What is a Cyclical Industry
A cyclical industry is a type of industry that is sensitive to the business cycle, such that revenues generally are higher in periods of economic prosperity and expansion and are lower in periods of economic downturn and contraction. Companies in cyclical industries can deal with this type of volatility by implementing employee layoffs and cuts to compensate during bad times and paying bonuses and hiring en masse in good times.
What's a Cyclical Industry?
BREAKING DOWN Cyclical Industry
Cyclical industries are sensitive to business cycles, so downturns in the cycle force consumers to prioritize expenses and potentially pare some costs 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, because no matter how bad times are, most people find a way to pay their light bill.
The Business Cycle
The business cycle is comprised of four discrete phases. During the expansionary phase, productivity grows, unemployment shrinks and stock markets tend to rise. Because more people are employed during this phase and their investment 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. Recessions occur during the contractionary phase, though not all periods of contraction result in recessions. In the United States, two consecutive quarterly declines in gross domestic product (GDP) represent the most common criteria of an economic 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 people buy with discretionary income, also is highly sensitive to the business cycle, because discretionary expenses are easier to cut from a consumer's budget during hard times rather 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 fiscally conservative vacations closer to home (if they go at all) and avoid expensive air travel.