2015 Industrials Trends
Companies in the industrial sector continue to do well, but they must use their cash to boost digitization efforts and expansion strategies.
Although the global economy is still struggling to find its footing since the recent recession, the gathering strength of the industrial sector around the world has been one of the most positive developments. More productive and cost-efficient manufacturing techniques, increased M&A activity, and the “reshoring” of factories as low-cost manufacturing countries become less competitive primarily drove the sector’s newfound resurgence. We expect further growth as the demand for parts escalates from robust industries, such as airlines, automotive, energy, and building products.
Of the major economic zones, the U.S. appears to be among the healthiest. And the performance of the nation’s industrial sector is a significant part of the improvement. The numbers for the first half of 2014 are revealing. Revenue growth for the sector — which includes subsectors as varied as construction and materials, industrial machinery, and industrial transportation — was up 3.2 percent compared with the same period in 2013. Net income margins rose to 7.3 percent in the first half of 2014 from 6.9 percent for all of 2013.
Perhaps most importantly, industrial capacity stood at 78.9 percent in October 2014, almost a full percentage point ahead of the previous year — despite a 3 percent increase in available capacity. It marked the fifth consecutive year of gains, putting companies in a position of being able to turn down less profitable projects.
Even in Europe, which has been wrestling with erratic economic growth, industrial companies are holding their own. According to a 2013 PwC survey (pwc.com), the leading global industrial companies achieve impressive EBIT margins of 17.3 percent on average. And in China, the number of industrial firms have more than doubled since 2000.
We believe the industrial sector will continue to prosper in 2015, but precisely how much individual companies will keep growing will depend on the efficacy and boldness of their investments in three key areas: digitization, expansion, and people. (See “Is Your Company Fit for Growth?” by Deniz Caglar, Jaya Pandrangi, and John Plansky, strategy+business, Summer 2012.)
The digital transformation
Far too many industrial companies make the mistake of believing that new digital technologies are best suited to consumer-oriented companies. Thinking that way is fast becoming a losing proposition. From essential needs such as accurate, resilient supply chains to enhancements in product design and production, digital tools have already become critical differentiators.
Digital tools have already become critical differentiators.
Consider the degree to which digitization is improving how industrial companies integrate their activities with their partners and customers. Thanks to new tools, manufacturers are collaborating more closely with key suppliers on the codevelopment of parts and systems and gaining better insight into the supply chains that feed manufacturing and distribution. Advanced analytics are aiding in the understanding of market trends and improving demand planning while simultaneously communicating product changes throughout the supply chain.
Industrial firms are investing in digitization opportunities within their sales operations, as well, equipping their field sales teams with mobile devices and visual tools rather than printed brochures. These technologies are helping sales forces quickly configure products as customers require, while providing those customers with greater insight on prices and lead times.
By incorporating into products digital advances such as sensors and other machine-to-machine (M2M) technologies — otherwise known as the Internet of Things (IoT) (strategy+business) — some industrial companies offer such capabilities as real-time performance monitoring, quality management, and rapid response to product failures.
Companies moving quickly on this front have been able to distinguish themselves from competitors, even as they take these technologies to the factory floor, where, combining IoT developments with robotics and other advanced techniques, they can now better monitor and control all kinds of manufacturing activities.
In addition, 3D printing offers the potential of bringing dramatic change to the factory floor, reshaping operations on a scale similar to the IoT. Although it is still early in 3D printing’s development, industrial firms should pay attention to its implications — both the risks and opportunities. It is critical to anticipate the way 3D printing will interact with other plant machinery and the degree to which it needs to be integrated into new manufacturing equipment.
Many are also investing in digital back-office systems for managing products in the marketplace. Business intelligence systems, for example, can help companies better understand just how profitable their different product lines are, content and knowledge management technologies can improve the management of intellectual property, and data analysis and synthesis capabilities can help companies cope with the mountains of data generated by the sensors embedded in their factories and the products they build.
The industrial sector has seen a burst of M&A activity over the past several years. More than 1,900 deals were completed in 2013 in the United States alone, for a total of almost US$70 billion, and 2014 will likely reach similar levels. Deal valuations, too, were sky-high, averaging 11.7 times EBITDA in 2013. And that doesn’t count the number of proposed acquisitions that were rejected by sellers seeking even higher multiples. We expect M&A transactions to increase markedly, given how cash-rich the sector is as a whole.
Industrial firms are already bulking up their corporate development staffs to take advantage of all the activity. Whether their expansion strategies and operational capabilities are tightly aligned with the nature of the markets they may be hoping to enter, however, is a different story. Diversification merely for its own sake is not a winning strategy (strategy+business), and the list of companies that have found themselves adrift and losing money in unfamiliar markets is long.
Indeed, in many cases, consolidation is the best route to expansion for industrial companies, because it involves zeroing in and doubling down on what they do best and on what differentiates them from their competitors. For this strategy to succeed, however, companies must concentrate fully on those capabilities and products that distinguish them in their chosen markets, while minimizing their investments in other activities.
A firm focused on small-batch, high-performance materials products, for example, would do better to consider buying or merging with firms that similarly have strong research and development capabilities and the ability to price competitively; both of those factors can make the most of the intrinsic high gross margins in their sector.
Deals that might help such a firm build a supply chain cost reduction capability that saves mere pennies would likely destroy firm value. For high-volume, large-batch manufacturers supplying stable long-term contracts, the reverse is true. But those in the middle must think carefully about how and where to invest, because if they make the wrong bet, they are unlikely to survive.
Moreover, industrial firms should be more aggressive in adopting new methods for reaching out and understanding new markets or targeting specific customers (for example, OEMs) and their product sets; these methods include rich information accessible through market research tools such as online surveys and social media. When combined with input from industry experts and deep research into the sector, these tools can help create a mosaic of insights into unknown markets for different products, different customer bases, and new territories.
Finding the people
The industrial sector is already struggling to find and keep the skilled people it needs, both on the shop floor and in the office. In the U.S. the unemployment rate in the sector decreased to 4.5 percent in September 2014, down from 6.9 percent in 2013, in part because of an aging workforce and younger workers shunning industrial manufacturing jobs for more glamorous sectors, like high-tech. As a result, talent scarcity could worsen in the coming year and wages are poised to rise in the near future.
The industrial sector is struggling to find and keep the skilled people it needs.
As companies look to invest in growth, talented people will become more critical at every stage of an industrial firm’s operations. The advent of digitization will require new expertise in a variety of fields — not just product development, manufacturing, and IT, but also marketing, customer interaction, corporate development, and more.
Finding and attracting these people will take money — companies must invest in widespread recruitment and greater promotion of the industry’s possibilities, benefits, innovation opportunities, and prospects. This task also demands industrial companies’ willingness to be flexible in how workers are managed, which often requires giving younger workers the freedom to be creative and more involved in areas that were typically off-limits to prior generations of factory floor employees, such as product and plant efficiency improvements.
Enter, the future
Global industrial companies have a unique opportunity to build on the gains that the sector has enjoyed recently. They have plenty of cash now, but to maintain their growth in the coming years, they must invest it thoughtfully, with the goal of differentiating themselves through digital innovation, more knowledgeable relationships with their customers, labor force improvements, and smart expansion strategies.