Surviving in Stagnant or Declining Industries
New Realities Require New Game Plans

by Bob Angart

Feb 1, 2002

(TMA Global)

In their heydays, declining industries were probably growth industries. Today, however, they find that demand for their products has been shrinking for some time. What strategy alternatives should companies finding themselves in such predicaments consider?

All too often within the corporate turnaround field, practitioners see resale values of business’s assets shrink as industry demand declines. Therefore, the most frequently recommended strategy has been a “harvesting” procedure that involves reducing investment levels to generate higher cash flows, followed by divestiture.

Unfortunately, harvesting can often become synonymous with abandonment. As demonstrated recently in segments of the steel industry, finding buyers can be difficult, and liquidation is often impractical. One wonders if airlines and major entertainment destination businesses are also now at risk for such harvesting.

The biggest challenge for many companies in the next few years will be managing businesses that compete in stagnant or declining markets. Sticking around for the long haul requires courage. Running a business in a declining industry also calls for an entirely new game plan than the one a company relied upon through a period of market growth.

To stay alive in a declining industry, companies must avoid battling for market share. They also have to control costs, keep customers coming back with flawless service and improved products, and maintain employee goodwill. Generally speaking, companies constantly need to reinvent not only the ways they do business, but also the services or products they offer to keep pace with changing expectations and demand.

The nature of competition during a decline and the strategic alternatives for coping with these changing conditions are complex. The experiences of industries that have gone through significant declines in sales over periods of time differ markedly. Some industries, such as salt mining and liquid paper, have aged gracefully and maintained extremely high profitability. Others, such as rayon and steel, have declined steadily, experiencing market deterioration characterized by excess capacity that helped depress prices.

Environmental Factors

Factors that determine if the environment of a declining industry will become hostile are demand characteristics and exit barriers. [1] Demand decline occurs for several reasons, including technological advances, changes in lifestyles or tastes, and substitute products. Examples include refrigerators replacing iceboxes, calculators taking the place of slide rules, and more recently, handheld electronic organizers replacing traditional paper organizers. Expectations concerning future demand affect the competitive environment that develops. How fast an industry declines depends on how quickly companies withdraw capacity.

Exit barriers are factors that dissuade firms from making easy and timely departures from industries. The higher the exit barriers, the more hostile the industry becomes during its decline.

Exit barriers assume a variety of forms. For example, if the assets are specialized to the business, their diminished liquidation value creates exit barriers. A significant exit barrier arises when it is difficult to reinvent a company or the firm lacks the ability to do so. Other potential barriers include labor settlements, long-term contracts, pension liabilities, and the costs of dismantling plants and equipment.

Early exits by competitors that have sizable market shares can create a more favorable environment for firms that remain. Exits by major competitors should make available new customers who require alternative suppliers. On the other hand, a hostile environment is likely to materialize if an industry has several competitors that have diverse goals and face high exit barriers. Because of declining sales and excess capacity, competitors in a declining industry are likely to resort to price wars, as demonstrated in the steel industry and more recently in the catalog print market.

Competitors’ ability or willingness to remain in the industry and fight for a shrinking number of customers is shaped in large part by the exit barriers they face. Therefore, it is imperative that they understand competitors’ operating costs and break-even points. Firms that do not have staying power are more likely to incite price wars in desperate attempts to retain volume to cover their fixed overhead expenses. Firms that enjoy low break-even points are less likely to need pricing as a weapon.

In a declining or stagnant industry, there may be many years left in a product’s life cycle. But it is essential for managers not to let wishful thinking color their judgment. Instead, they must survey the competitive landscape accurately, assess long-range prospects, and face up to the problems inherent in competing in a stagnant or declining marketplace. Management’s acceptance of the reality of continued slowing demand is a prerequisite for developing successful survival strategies.

Strategy Options

Obvious strategies in a declining market are to make a fast exit or milk the business in an attempt to get every last drop of profit without adding significant amounts of new capital. But these aren’t always the best strategies, especially if all of the other players are leaving the playing field at the same time.

Research conducted by Richard G. Hamermesh and Alvin J. Silk of the Harvard Business School uncovered three common characteristics of strategies that businesses have used to succeed in stagnant and declining industries. [2] These companies:

  • Identify growth or niche segments within their industries
  • Emphasize product quality
  • Consistently improve the efficiency of their manufacturing and distribution systems, lowering their break-even points

Given these realities, there are a number of approaches that not only can prevent a company’s extinction but also offer it hope for a reasonable return on investment.

Leadership. A firm might consider adopting a leadership strategy if it is produces its product cost-efficiently, is clearly identified as the industry leader, or sells a well-accepted, branded product. A firm following the leadership strategy tries to achieve profitability by becoming one of the few companies remaining in the industry.

Firms can achieve leadership positions by building market share through competitive pricing, or they can reduce competition by acquiring their rivals’ product lines. They can also raise the stakes investing in new, more efficient processes, thereby forcing competitors to dedicate additional capital to keep pace. Because leadership strategies may trigger price wars and require significant investments of capital, this approach should be considered only by firms that have deep pockets.

Niche. The niche strategy is better suited to firms that are not in the strongest of competitive positions within their industries. In this approach, they select a specialized, lucrative group of their customers to continue serving and sell or shut down other product lines and plants to cut costs.

A niche strategy is appropriate if groups of loyal customers can be served profitably. For example, Harley-Davidson survived by not trying to be everything to everybody and instead concentrating on a niche market. It left most of the motorcycle market to the Japanese and sold high-horsepower “hogs” to a small segment of motorcycle enthusiasts—and became quite profitable in the process.

At times, managers are too busy trying to divest to spot potential niche customer bases. For example, computer cards once consumed 450,000 tons of paper a year. Most card makers vanished after computer chips made the cards obsolete for programming purposes.

One survivor, however, was JTC Corp. of Union, N.J. The company identified card customers who used the cards for purposes other than computer programming and who hadn’t found better substitutes. The company found demand for the cards from factories that liked the products because they fit easily into boxes of parts left in inventory. Also, as the last presidential election demonstrated, cards are still used as ballots by voters in some precincts.

Growth Segments. Perhaps the best way to avoid some of the unpleasant realities of a stagnant or declining industry is to concentrate on growth segments within the industry. Although that may not be possible in some industries, growing markets can be identified in most, despite overall decline or stagnation. For instance, the technology for making paper has been around for centuries. However, manufacturers of specialty papers have recently found many untapped markets for their products.

Identifying growth segments requires considerable insight and creativity and is often difficult. However, a creative management team willing to view its declining industry as being composed of smaller segments and willing to take the time to analyze industry data is much more likely to identify segments with growth potential.

Improved Manufacturing/Distribution. One of the overriding characteristics of firms operating successfully in stagnant or declining industries is their constant attention to cost reduction. The most common way to lower costs seems to be through improving processes for manufacturing and/or distribution.

In many instances, cost reductions are achieved through gradual, day-to-day improvements and attention to detail rather from big breakthrough investments. For example, a precision machine manufacturer/supplier to the auto industry was saved from going out of business by implementing a detailed scheduling system, performance planning, and product standardization using off-the-shelf software. Often, more creative and less complicated approaches can provide significant cost reductions.

Although improvements in manufacturing processes are the most common way of lowering costs, other efficiencies can be achieved. The planned, orderly consolidation of production facilities can dramatically impact profitability. A renewed focus on reducing rework and spoilage can improve gross margins significantly. As more consumers shop on the Internet, web printers with the lowest make-ready cost and run waste may be the ones to sustain profitability in the highly competitive catalog printing market.

Divestiture. Divesting entails getting out of a business in an orderly fashion. For this strategy to succeed, timing is essential.

Companies adopt divestiture as a strategy when management assumes the firm can recover more of its investment from the business by selling it in the early stages of decline, when companies can recoup higher values from the sale of assets. Companies that do not enjoy leadership positions, cannot serve differentiated groups of customers, or cannot achieve the lowest break-even points in their industries should consider this alternative.

The objective of this strategy is to sell a business before the value of its assets shrinks too much. In the early stages of decline, there is more uncertainty about future demand and thus more likelihood that a buyer can be found. Divestiture is an appropriate option when more promising uses for a firm’s resources are available.

Timing, Analysis

In any scenario, a company should choose an appropriate strategy early in the game rather than react to someone else’s plans later. The strategy selected should match the industry structure and demand characteristics against a company’s own strengths and weaknesses.

By recognizing the basic patterns that match strategic alternatives with these variables, a firm is in a better position to select an optimal strategy in a declining or stagnant industry. Prudent timing and careful analysis of industry characteristics can result in improved performance, even in declining industries.

References

[1] Willoughby, Jack, “Endgame Strategy,” Forbes, July 14, 1987, 181-182. 

[2] Hamermesh, Richard G. and Silk, Alvin J., “How to Compete in Stagnant Industries,” HBR , Sept. – Oct. 1979, 161-168.

Bob Angart CPA, MBA
Turnaround and Crisis Manager
Centrus Group
angart@centrusgroup.com
 

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