What is a 'Cyclical Industry'
A cyclical industry is a type of industry that is sensitive to the business cycle, such that revenues are generally higher in periods of economic prosperity and expansion and lower in periods of economic downturn and contraction. Companies in cyclical industries can deal with this type of volatility by implementing layoffs and cuts to compensation during bad times and paying bonuses and hiring en masse in good times.
BREAKING DOWN 'Cyclical Industry'Downturns in the business cycle force consumers to prioritize expenses and potentially cut out some that are not essential. Therefore, industries that focus on nonessential products face the biggest risk of revenue loss when economic contraction takes hold. By contrast, industries such as utilities tend to weather economic storms much better, as no matter how bad times are, most people find a way to pay their light bill.
The Business Cycle
Four discrete phases comprise the business cycle. During the expansionary phase, productivity grows, unemployment shrinks and stock markets tend to rise. Because more people are employed during this phase and their portfolios are growing, they have more discretionary income and are less reticent about spending it. The peak follows the expansionary phase. At this point, the economy has reached the end of expansion and subsequently begins its contractionary phase.
Discretionary income falls during contraction, as more people are unemployed and productivity is lower. The contractionary phase is when recessions occur, though not all periods of contraction result in recessions. In the United States, two consecutive quarters of gross domestic product (GDP) decline represent the most common criteria to declare an official recession. The final phase of the business cycle is the trough. This phase is where the economy bottoms out before starting the cycle anew and commencing another contractionary phase.
Examples of Cyclical Industries
Industries involved in the production of durable goods, such as raw materials and heavy equipment, tend to be cyclical. Consumer discretionary goods, a sector focused on products and services that consumers purchase with discretionary income, is also highly sensitive to the business cycle, as discretionary expenses are easier to cut from a consumer's budget during hard times than essential costs.
For example, the airline industry is a fairly cyclical industry. In good economic times, people have more disposable income, so they are more willing to take vacations and make use of air travel. Conversely, during bad economic times, people are much more cautious about spending. As a result, they tend to take more conservative vacations closer to home (if they go at all) and avoid expensive air travel.