Strategy& [www.strategyand.pwc.com] – We would like to offer our thoughts on the current business environment for industrial companies, what the future holds, and the best course forward.
Where We Stand
Call it the age of uncertainty-this post-Great Recession environment when a weak recovery and any number of troubling signs globally cast shadows on relatively strong recent profit results. The future for industrial companies is a somewhat confusing blend.
On the plus side, industrial revenues (unadjusted for inflation) in the first nine months of 2011 topped levels last seen in the peak year of 2008, and earnings in this period were up 25 percent compared to January through September 2010. Average net profit margins at industrial firms are relatively robust again: about 6 percent now, a 6 percent improvement over last year. Emerging economies drove most of this growth, as real GDP gains in developed nations slowed to a meager 1.5 percent in 2011. In addition, the Dow Jones Industrials Index was down only 5.7 percent compared to an 11.4 percent drop in the overall stock market during that period.
The bad news, though, is that there is bad news-and it can’t be easily ignored. For one thing, consumers and companies are still hesitant to spend their money-the Purchasing Managers Index tumbled in the first nine months of 2011, to 51 from 61-and unemployment remains stubbornly high. Concerns persist that a second global recession-a double dip-is increasingly possible. Perhaps even more disconcerting, no matter what happens in the developed economies, GDP growth is already slowing in the most important emerging nations.
Given this uneven blend of trends and forecasts, it’s little surprise that industrial companies have been conservative strategically. This can be seen, for example, in the pace of mergers and acquisitions. Although at the end of 2010, industrial outfits were relatively flush-cash on hand surpassed 14 percent of revenue compared to an average of about 9.5 percent during much of the past decade-the popularity of M&A has flagged recently. In the first nine months of 2011, the number of deals fell by at least 25 percent.
Instead of acquisitions, most successful industrial companies have been content to cut costs, prune their product and business unit portfolios, deleverage, and hoard cash. While that approach has perhaps put these companies in a position to navigate uncertainty, it is nonetheless a questionable tactic. Simply put, if industrial firms sit on the sidelines with their cash for too long, they may end up under-investing in their businesses and innovation-and minimizing their growth prospects.
Over the next few years, we believe, industrial companies should view the glass as mostly half-full. They should have enough cash on hand to weather a crisis or two, but more important, they should use this time to put their money to work, particularly when many of their rivals will likely be reluctant to make bold moves. In other words, this is a perfect moment for smart industrial companies to invest in developing the capabilities, assets, and strategic intelligence that allow them to achieve and sustain competitive advantage and that prepare them to take a leading position in their industrial sectors when opportunities for growth emerge.
A Capabilities Strategy
We define capabilities as the three to six distinctive strengths your company has (or should develop) to set it apart from competitors. Each capability is built on a combination of processes, tools, knowledge, skills, talent, and organization.
The following capabilities stand out as the most essential for industrial companies to develop and align:
- Agile Product Development and Strong-Form Product Management
Product life cycles are decreasing as the pressure of competition and technology breakthroughs drive frequent product upgrades, if not entirely new offerings.
- Cost Fitness
Through top-down, across-the-board budget cuts of, say, 5 percent or more a year, operational expenses may be trimmed to the bone, but to what end?
Decades of relentless focus on cost cutting have left industrial supply chains vulnerable to disruptions like the earthquake.
In the industrial sector, IT has typically been viewed as a cost to be managed and minimized. But that’s not viable anymore.
Rapid advances in new digital technologies offer industrial companies a wide swath of tools that can be used to take advantage of new opportunities ranging from improving equipment productivity to customer data management and analysis.
Winning the Talent War
Despite high unemployment rates in developed countries, the supply of skilled workers who can engineer, design, sell, and service industrial products is meager at best.
Developing the BRIC Markets
The BRIC economies may be slowing a bit, with less than 7 percent GDP growth forecast through the end of 2012, but for many industrial companies they represent the best opportunities for growth.
We would welcome the opportunity to hear your thoughts about the year ahead. ♦