• Shipping – see Sink or Swim on massive over-building [also discussed in my presentation on lessons from the crisis]
• Commercial real-estate – see article on office vacancy.
• Insurance – can’t say more on this at the moment, as there’s a client opportunity, but there is crystal-clear evidence of the big swings in profitability in this industry too.

As I say, the frustrating thing is that we know why it happens, and some strategies for coping with it or even damping it down. Three observations in particular stand out.

1. It is worse if the sector is fragmented – the more small players you have, the higher the chance that some of them will be foolish, so managing competitive entry [legally!] is vital. 
2. Cycles last many years, so it is especially important in these sectors that firms tell investors about the realities and do not get pushed into over-investment and over-borrowing.
3. The time-scales are long, so solid experience amongst senior management is vital. 

An especially annoying consequence of all this is the appalling environmental damage that can result in some cases, such as the vast tonnage of unwanted ships to be scrapped and the equally vast acreage of unwanted office space, both of which drove consumption of enormous quantities of natural resource and carbon emissions.

Cyclicality afflicts many industries, not just basic materials like steel, paper-pulp and chemicals, but other sectors including shipping, insurance and office space. They suffer far worse cyclicality in price-levels and profitability than can be explained by variability in the markets they serve – why?

How these industries behave

What these industries have in common is that capacity increases come in large lumps and take a long time from any decision to raise capacity and that increase coming on-stream. So, any growth in demand leads to tightening supply and rising prices and profitability. Many firms respond by announcing new capacity, and during the delay while shortages persist, prices and profits sky-rocket, leading to still more plans for new capacity. Eventually, that capacity all comes on-stream, grossly exceeding demand levels, and prices collapse for as long as it takes for demand to grow to match – often many years.

A further mechanism is that during the up-turn, investors take some time to be persuaded that higher prices and profits are real, adding a still further delay and exaggerating the boom and bust still further.

How to manage strategy in cyclical industries

Dealing with these circumstances was certainly documented as long ago as 1996, though experienced executives in many of the industries affected by cyclicality had long known intuitively what to do:

• first, do not spend money on building new capacity when demand exceeds supply and prices and profits are strongest – every else will be doing the same
• instead, take all the excess margin and build up cash reserves
• when excess capacity comes on-stream and prices and profits collapse, competitors will be in trouble, and you can use the capital war-chest to buy fire-sale assets or entire companies
• take the opportunity to shut down inefficient capacity, either amongst what you had before or acquired, to shorten the time when supply exceeds demand
• if underlying demand looks healthy, invest in new capacity before prices and profitability recover, so that it will come on-stream in time to take most of the share of any increased demand.

[BEWARE - as with all strategy principles, this one should be checked carefully to make sure it's right for you under the circumstances you face.]

The Economist article implies that many of the big firms in basic industries ignored these principles, bet the farm on demand growth going on for ever, and made matters worse by borrowing heavily – resulting in still greater excess capacity than would otherwise have been the case. Were they really not aware of age-old wisdom, had never read this or other articles on the issue, or did they just hope that gravity had been abolished?

The interesting extension of this story is that the naive strategy of ‘build-capacity-when-demand-is-exploding’ seems to have infected many, many industries that would not normally have been susceptible to the problems in 2005-07, just as it did between 97-99.

We are still waiting to hear where the consultants were who should have been advising caution .. and did the strategy academics have anything to say on the subject? If you were a consultant or strategy professor who urged caution, or a business who received that advice, do let us know.

With the downturn accelerating, there will be many more examples of weak firms forced to surrender potentially valuable resources – especially capacity and people – to those whose sound strategic management avoided getting into trouble. In the extreme, this will involve absorbing those weaklings in total. Smart firms in cyclical industries, from petrochemicals to paper to insurance to construction, have long known how to exploit the short-sightedness of others. See for example ‘Managing Capacity in Basic Materials‘ – though the principles are far more widely applicable than just in ‘basic materials’.