What Is Obsolescence Risk?
Obsolescence risk is the risk that a process, product, or technology used or produced by a company for profit will become obsolete, and thus no longer competitive in the marketplace. This would reduce the profitability of the company.
Obsolescence risk is most significant for technology-based companies or companies with products or services based on technological advantages.
Understanding Obsolescence Risk
Obsolescence risk is a factor for all companies to some degree and is a necessary side effect of a thriving and innovative economy. This risk comes into play, for example, when a company is deciding how much to invest in new technology. Will this technology remain superior long enough for the investment to pay off? Or will it become obsolete so soon that the company loses money?
Obsolescence risk also means that companies wanting to remain competitive and profitable need to be prepared to make large capital expenditures any time a major product, service, or factor of production becomes obsolete.
Budgeting for obsolescence risk is challenging because it is difficult to predict obsolescence and the exact rate of technological innovation.
Example of Obsolescence Risk
A publishing company is an example of one that faces obsolescence risk. As computers, tablets, and smartphones have become more popular and affordable, more consumers have started reading magazines, newspapers, and books on these devices instead of in their print forms.
For the publishing company to remain competitive, it must minimize its investments in the old paper publications and maximize its investments in new technologies. Even as it makes this shift, it must remain alert to new and unimagined technologies that could supplant the currently popular ways of reading and require still more investment.
The stock market "graveyards" are littered with dead companies whose products or technology were rendered obsolete. Examples are the technology companies Control Data and Digital Equipment from Morgan Stanley's 1982 “recommended” buy list.
- Obsolescence risk arises when a product or process is at risk of becoming obsolete, usually due to technological innovations.
- Reducing obsolescence risk means being ready and able to make capital expenditures and investments in new technology and processes.
- Technology-based companies or companies that rely on technological advantages are most vulnerable to obsolescence risk.