Asia competition barometer precision engineering

Asia Competition Barometer Precision engineering An Economist Intelligence Unit report Supported by Asia Competition Barometer: Precision engineering Contents Preface Executive summary Asia’s growing importance for corporate performance and global competitiveness Competition and profitability at Asian firms Competition: Marginal increase Profitability: A return to the peak Case study: World Precision Machinery 7 11 Positioning for success in Asia Sustained growth in Asia Semiconductors and solar: Asian growth stories Case study: Applied Materials 12 12 13 15 Outlook 16 Barometer methodology 18 © The Economist Intelligence Unit Limited 2012 EDB_Engineering_main.indd 1 3/6/2012 8:40:30 AM Asia Competition Barometer: Precision engineering Preface Supported by Singapore’s Economic Development Board (EDB), the Economist Intelligence Unit has developed the Asia Competition Barometer with the aim of understanding the changing market dynamics in key sectors and assessing the intensity of competition in them Drawing upon company-level data on profitability and other indicators, the Barometer quantifies the changing dynamics of competitiveness in Asia for select industries between 2004 and 2009 This report focuses on the Barometer findings for the precision engineering (PE) sector Assessing a universe of over 200 PE companies that are publicly listed in eight countries—China, India, Indonesia, Malaysia, the Philippines, Singapore, Thailand and Vietnam—the Barometer examines changing profitability and the competition landscape for the sector Other reports in this series look at the information technology services, petrochemicals and chemicals, pharmaceuticals, and transport and logistics sectors in Asia January 2012 EDB_Engineering_main.indd © The Economist Intelligence Unit Limited 2012 3/6/2012 8:40:31 AM Asia Competition Barometer: Precision engineering Executive summary W hat does the emergence of Asia as a major engine of global economic growth mean for companies operating in the region? Asia’s robust economic outlook—coupled with diminished growth prospects in many other parts of the world—has attracted new investment into the market both from regional players and Western multinationals As a result, competition in the region is expected to intensify Given the darkening global economic outlook, and the expected impact on some economies and sectors in the region, growth and profitability look uncertain in the near term But over the medium to longer term, Asia’s strong economic fundamentals will ensure consistent growth across a range of industries How are companies positioning themselves to capitalise on Asia’s growth over the next few years? The Asia Competition Barometer assesses the intensity of competition and changing market dynamics in several key sectors This report examines the precision engineering (PE) sector, which includes the following sub-segments: instruments and appliances for measuring, testing and navigation, irradiation, electromedical and electrotherapeutic equipment, optical instruments and photographic equipment, power-driven hand tools, metal-forming machinery, other machine tools, other special-purpose machinery, air and spacecraft and related machinery and medical and dental equipment and supplies Among the key findings of this report are the following: • Over the past decade, Asia’s emergence as a manufacturing powerhouse has led to a boom in demand for PE products PE components and machinery form the backbone of many industrial processes, including in the automotive, aerospace and defence, consumer electronics, solar energy and medical device sectors As manufacturing firms in Asia move up the value chain to produce ever more sophisticated products, they will further boost demand for PE products • Profitability in Asia’s PE sector has continued to grow, despite the global financial crisis Profitability plummeted in 2005, but since then has steadily increased The average gross margin of publicly© The Economist Intelligence Unit Limited 2012 EDB_Engineering_main.indd 3 3/6/2012 8:40:31 AM Asia Competition Barometer: Precision engineering listed Asian firms declined from 43.1% in 2004 to 27.6% in 2005 This was due largely to an increase in competition and a spike in material costs that year The average gross margin then rose steadily to reach 37.4% by 2009 Of the five sectors that the Economist Intelligence Unit analysed for this Barometer, PE is the only one where profitability continued to grow uninterrupted through the last global economic slowdown, partly due to strong regional demand Combined operating revenues increased from US$26.6bn in 2007 to US$35.1bn in 2009 f 296 ces 004 re ed l • Rising private consumption in Asia has boosted demand for PE products and services, but whether it can replace demand in the West remains to be seen The rise of Asia’s middle class has been accompanied by an increase in discretionary spending, particularly on goods such as cars, mobile phones and computers This has, in turn, driven growth in the region’s PE sector Still, it remains to be seen if this indigenous regional growth will be able to offset the likely slowdown in demand in the West over the next few years PE firms’ success over the next few years will depend on how accurately they have planned for and managed this shift, particularly given the broader global macroeconomic uncertainty • The PE industry is evolving rapidly, as low-cost Asian producers and high-technology Western firms seek to acquire each other’s competitive advantages Global PE firms have been moving into Asia to tap its burgeoning market, and to lower their production costs by shifting capacity from higher-cost countries to Asia Meanwhile, Asian companies have been adapting to this competitive threat by placing a greater emphasis on technological advancement in order to move up the value chain and produce more sophisticated machinery Asian PE firms are eager to transform from being simple contract manufacturers to providing production and supply chain management capabilities This emphasis is reflected in a five-fold increase in Asian firms’ total R&D expenditure between 2004 and 2009 As a result, Asia’s PE industry has been witnessing the confluence of two hitherto distinct business models • The number and size of players in Asia’s PE sector is growing The number and size of publicly-listed firms in the PE sector in Asia has increased dramatically The total number of listed companies in the industry increased 57% between 2004 and 2009, from 131 firms to 206 Over the same period, the total combined revenue of publicly-listed PE companies more than tripled from US$9.8bn to US$35.1bn; these firms’ combined total assets rose from US$13bn to US$63.3bn • Competition has increased only marginally, with the industry’s biggest players continuing to expand their positions Competition in the PE industry grew significantly between the years 2004 and 2006, largely due to an influx of new players into the sector However, between 2006 and 2009, the largest firms in the industry began to steadily increase their concentration, partly by exploiting economies of scale A related trend that has benefitted large firms is greater vertical integration, as PE companies seek to diversify their product offerings and provide more comprehensive end-to-end services to their customers In the future the sector is likely to be characterised by fierce competition between big Asian and non-Asian players, who may increasingly resemble one another EDB_Engineering_main.indd © The Economist Intelligence Unit Limited 2012 3/6/2012 8:40:31 AM Asia Competition Barometer: Precision engineering Asia’s growing importance for corporate performance and global competitiveness O ver the past decade, Asia has rapidly grown in importance to the global economy Its share of global GDP, measured in purchasing-power parity terms, increased from 26.8% in 2001 to 33.8% in 2010.1 By 2016, the Economist Intelligence Unit (EIU) expects this proportion to rise to 38.9% There are several broad trends that have been driving Asia’s precision engineering (PE) sector.2 The first is Asia’s emergence as a global manufacturing powerhouse Over the past decade, Asia’s share of global manufacturing output has increased dramatically, led by China (see Figure 1) This has boosted demand for PE products that are used to manufacture a variety of goods The second trend, which is helping to underpin the first, relates to rising private consumption in Asia, which is boosting regional demand for manufactured goods Due to Asia’s rapid economic growth over the last few years, the region is now home to a huge and growing middle class The Asian Development Bank (ADB) estimates that between 1990 and 2008 developing Asia’s middle class population more than tripled from 565m to 1.9bn As a share of the total population, the middle class grew from 21% to 56% over that period.3 Figure 1: Share of world manufacturing output (%, constant 2000 US$) 2000 2009 15 12 Asia here includes Bangladesh, China, Hong Kong, Indonesia, India, Japan, South Korea, Malaysia, Myanmar, Philippines, Pakistan, Singapore, Sri Lanka, Thailand, Taiwan, and Vietnam The precision engineering sector includes the following sub-segments: instruments and appliances for measuring, testing and navigation, irradiation, electromedical and electrotherapeutic equipment, optical instruments and photographic equipment, power-driven hand tools, metal-forming machinery, other machine tools, other special-purpose machinery, air and spacecraft and related machinery and medical and dental equipment and supplies “The rise of Asia’s middle class” Asian Development Bank 2010 China ASEAN South Korea Taiwan India Source: UNIDO © The Economist Intelligence Unit Limited 2012 EDB_Engineering_main.indd 5 3/6/2012 8:40:31 AM Asia Competition Barometer: Precision engineering Figure 2: Asia and Australasia consumption Cars (per 1,000) 120 Mobiles subs (per 100) PCs (per 100) 100 80 60 40 20 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Source: Economist Intelligence Unit Earth Policy Institute, 2001 EDB_Engineering_main.indd These new consumers have been spending on products such as cars, mobile phones and computers Between 2001 and 2010, mobile phone penetration in Asia and Australasia rose from 10.9% to 70.6% while personal computer penetration increased from 4.4% to 18.7% (see Figure 2) Over that same period, the stock of passenger cars per 1000 people in the region grew from 34.2 units to 54.1 Asia has some of the fastest growing automobile markets as well as some of the largest automobile manufacturers in the world In 2009, China overtook the United States as the world’s biggest car market Between 2011 and 2015, the EIU expects Asia to see 157.5m more passenger vehicles and 54.7m more commercial vehicles on its roads Importantly, all three markets continued to expand right through the global economic downturn in 2008-09, reflecting the resilience of Asian private consumption The EIU forecasts that by 2016, there will be 84.8 cars per 1000 people, while mobile and computer penetration will have reached 112% and 32.5% respectively The third trend driving Asia’s PE industry is the growing global interest in renewable energy, due to concerns over the environment and declining hydrocarbon stocks This is boosting demand for, among other things, solar photovoltaic (PV) cells, which use semiconductors made with PE products Asian manufacturers dominate the global industry in the production of solar PV cells Combined PV production in China, Taiwan and Japan increased from less than 700MW in 2004 to 16,800MW in 2010, accounting for some 70% of the 24,000 MW global production that year Russell Tham, regional president of Applied Materials South East Asia, says that although Applied Materials entered the solar business only in 2006, it has been the firm’s fastest growing segment, and now contributes about 20% of its revenues Applied Materials also now runs a solar R&D centre in Xi’an, China © The Economist Intelligence Unit Limited 2012 3/6/2012 8:40:31 AM Asia Competition Barometer: Precision engineering Competition and profitability at Asian firms T he number and size of publicly-listed firms in the PE sector in Asia has increased dramatically The number of listed companies increased 57% between 2004 and 2009, from 131 firms to 206 Over the same period, the total combined revenue of publicly-listed PE companies more than tripled from US$9.8bn to US$35.1bn, while their combined total assets rose from US$13bn to US$63.3bn Meanwhile, while there is no authoritative data on foreign direct investment in the PE sector, media reports and industry interviews indicate a rapid increase in investment The influx of new players, both Asian and non-Asian, into the region’s PE sector has led to a marginally more competitive operating environment Competition: Marginal increase With many companies raising their expectations of Asia to deliver growth and profits, it is reasonable to expect competition intensity in the region to increase To capture this intensity we have used the Herfindahl–Hirschman Index (HHI), which measures the market concentration of an industry’s largest firms HHI values can range from (extremely fragmented market) to 1.0 (monopoly) Here we have multiplied the values by 100 to achieve a scale consistent with profitability indicators (see below) The HHI for Asia’s PE industry decreased from 10.39 in 2004 to 9.30 in 2009, after having hit a low of 5.87 in 2006 (see Figure 3), signifying that the 50 biggest firms in the Barometer saw a marginal decrease in concentration between 2004 and 2009.4 Competition in the PE industry grew significantly between the years 2004 and 2006 The HHI dropped from 10.39 to 5.87 over that period, signifying that the market share of the 50 biggest firms declined substantially This is largely because of an influx of new players—in those two years, 40 new Asian companies entered the industry, capturing much of the rapidly growing market However, between 2006 and 2009, the largest firms in the industry began to steadily increase their concentration once again The HHI rose from 5.87 to 9.30 over that period There are two reasons for this © The Economist Intelligence Unit Limited 2012 EDB_Engineering_main.indd A measure of the size of companies in relation to the industry, and an indicator of the amount of competition among them, the HHI is defined as the sum of the squares of the market shares of the 50 largest firms from the universe of over 200 listed companies assessed For more information on the Barometer methodology, please refer to the last section in this report 3/6/2012 8:40:31 AM Asia Competition Barometer: Precision engineering Figure 3: Herfindahl–Hirschman Index 12 10 2004 2005 2006 2007 2008 2009 Source: Economist Intelligence Unit Herfindahl—Hirschman Index (HHI) 2004 2005 2006 2007 2008 2009 10.39 8.63 5.87 7.73 8.44 9.30 First, from 2007 to 2009, only a handful of new companies entered the sector, hence the incumbents were able to grow their market share Second, over the past few years, PE firms have engaged in fierce price competition, driving down costs by improving the efficiency of their production processes In this environment, the larger companies have been better able to exploit economies of scale, improving their competitive position and winning market share A related trend that has benefitted large firms is greater vertical integration, as PE companies seek to diversify their product offerings and provide more comprehensive end-to-end services to their customers The five largest companies by 2009 turnover—Larsen & Toubro, China CSSC Holdings, Xi’an Aircraft International, Taiyuan Heavy Industry and China Erzhong Group (Deyang) Heavy Industries—are significantly bigger than their peers (see Figure 4) Industry trends suggest that there will be increased price and technology competition in Asia NonAsian firms have entered the region over the last few years to lower their production costs and be closer to Figure 4: Top ten companies by turnover Company Country of origin 2004 turnover (US$bn) 2009 turnover (US$bn) Larsen & Toubro India 3.39 9.89 China CSSC Holdings Xi'an Aircraft International China N.A 3.80 China 0.15 1.24 Taiyuan Heavy Industry China 0.28 1.21 China Erzhong Group (Deyang) Heavy Industries China N.A 1.13 Shenyang Machine Tool China 0.47 0.90 KNM Group Malaysia 0.56 0.61 Hi-P International Singapore 0.44 0.59 Daheng New Epoch Technology China 0.43 0.49 Alstom Project India India 0.19 0.46 Note: These are the ten biggest companies by turnover that were analysed in the Barometer, which considered only publicly listed firms in eight countries: China, India, Indonesia, Malaysia, the Philippines, Singapore, Thailand and Vietnam EDB_Engineering_main.indd © The Economist Intelligence Unit Limited 2012 3/6/2012 8:40:32 AM Asia Competition Barometer: Precision engineering key clients Meanwhile, Asian companies that have hitherto competed mainly on price are now focussed on learning new technologies to move up the value chain, says Shao Jian Jun, executive director and CEO of World Precision Machinery, an integrated manufacturer of precision metal stamping machines As a result, these two previously distinct PE business models—broadly, the high-technology Western model and the low-cost Asian one—are beginning to meld Profitability: A return to the peak To measure the profitability of the PE sector, we developed a composite index of five ratios that measure different aspects of a company’s margins (for more details, see the note on methodology at the end of this report) According to our Barometer, with the exception of gross margin, all other profit margins have risen relative to 2004 (see Figure 5) There was a sharp fall in the Profitability Index in 2005, which can be largely attributed to a sharp fall in gross margin from 43.1% to 27.6%.6 Gross margin also declined marginally in 2006 to 27.2% The fall in gross margin in the years 2005 and 2006 can be attributed to an increase in competition and higher material costs First, the increase in competition in 2005 and 2006 (see Figure 3) could have had a negative impact on gross margins Second, in 2005 material costs more than doubled to US$3.5bn from US$1.6bn in 2004 Over that same year, combined operating revenues increased only 25% to US$12.3bn This hurt gross margins in 2005 Since that year, however, Asian PE companies have seen a steady, albeit gradual, increase in overall profitability resulting in the same levels of profitability in 2009 as in 2004 This can largely be attributed The composite Profitability Index is made up of five ratios that each represents a different aspect of a company’s profitability For more information on the Barometer methodology, please refer to the last section in this report Figure 5: Profitability Index 150 135 120 105 90 2004 2005 2006 2007 2008 2009 Source: Economist Intelligence Unit 2004 2005 2006 2007 2008 2009 126.1 100.0 102.2 111.8 117.5 126.1 EBITDA margin (%) 11.7 12.0 12.1 14.0 13.0 14.4 Gross margin (%) 43.1 27.6 27.2 30.5 34.2 37.4 Return on capital employed (%) 10.2 13.3 14.8 13.5 13.4 12.6 7.5 11.9 14.3 13.6 13.8 13.2 Profitability index Return on equity (%) Return on assets (%) Herfindahl—Hirschman Index (HHI) © The Economist Intelligence Unit Limited 2012 EDB_Engineering_main.indd 2.7 4.4 5.1 5.5 5.3 5.3 10.39 8.63 5.87 7.73 8.44 9.30 3/6/2012 8:40:32 AM Asia Competition Barometer: Precision engineering to operating revenues increasing faster than material costs from 2006 to 2009, contributing to higher gross margins Indeed, of the five sectors that the EIU studied for this Barometer, the PE industry is the only one where profitability continued to grow uninterrupted through the last global economic slowdown Combined operating revenues increased from US$26.6bn in 2007 to US$33.5bn in 2008 and US$35.1bn in 2009 This suggests that even though manufacturing exports to developed Western countries declined during this period, this was somewhat offset by indigenous Asian demand as well as growth in new manufacturing segments For instance, Asia’s production of solar PV cells increased significantly in both 2008 and 2009 Additionally, Asian manufacturers may have continued to invest in PE machinery in anticipation of future demand In the coming years, Mr Tham at Applied Materials expects to see “growth opportunities in the semiconductor industry propelled by the wireless and mobile markets, as consumers demand an increasingly networked society with visually rich and interactive devices anytime, anyplace” He expects a surge in consumption from the emerging world’s middle class as products become more affordable However, profitability will depend not only on global economic growth, but also on costs and technology Mr Tham believes that companies will need to continue investing in R&D to produce newer technologies at cheaper costs 10 EDB_Engineering_main.indd 10 © The Economist Intelligence Unit Limited 2012 3/6/2012 8:40:32 AM Asia Competition Barometer: Precision engineering Case Study: World Precision Machinery World Precision Machinery: Moving up the technology ladder World Precision Machinery (WPM), an integrated manufacturer of precision metal stamping machines based in Jiangsu, China, has seen its revenues multiply five-fold between 2005 and 2010 In the first nine months of 2011, the firm had revenues of RMB 947.9m (US$150.1m), amounting to year-on-year growth of 30% Shao Jian Jun, the company’s executive director and CEO, says WPM derives more than 95% of its sales from China currently and that Asia’s standing as the world’s manufacturing hub will continue to present business opportunities for the company as “the stamping industry forms the backbone of many manufacturing industries” WPM is currently one of the three largest manufacturers of metal stamping machines in China It mostly supplies manufacturers in home appliances (34% of revenues), automobiles (32%) and electronics (15%), while it earns the rest of its revenue from several other sectors Mr Shao attributes the profitability in the industry to “a boom in market demand, [the rising value of] brand names, price competitiveness and technology innovation” However, he adds © The Economist Intelligence Unit Limited 2012 EDB_Engineering_main.indd 11 that the intensity of competition in the sector in Asia has increased considerably “More and more manufacturing plants have moved into Asia,” he says Many non-Asian firms have set up plants in the region either independently or through joint ventures For instance, global players such as KLA-Tencor and Applied Materials have invested in manufacturing plants and research and support centres in destinations such as China, India, Malaysia, Singapore and Taiwan Mr Shao expects stiff competition in the PE sector over the next few years He says that Asian firms have started to move up the technology ladder, while non-Asian firms that have an Asian presence have started lowering production costs In the face of this rising competition, a key part of WPM’s strategy is vertical integration: the company has the capability to design 90% of the equipment it produces According to Mr Shao, over the next five years, profitability in the PE industry will be driven by market demand on the one hand, and cost control, production efficiency and price competitiveness on the other Technology innovation will also be important, he says This is reflected in WPM’s decision to employ more than 200 R&D and technical staff in two Chinese cities, Danyang and Shanghai 11 3/6/2012 8:40:32 AM Asia Competition Barometer: Precision engineering Positioning for success in Asia Sustained growth in Asia G iven the long-term structural problems in many Western markets and emerging Asia’s largely bullish economic fundamentals, the shift in trade and investment from the West to Asia will continue Asia’s economic growth is expected to continue outpacing the growth of OECD countries The EIU estimates that by 2016 the eight Asian countries in this study alone will account for 28.9% of global GDP (measured in purchasing-power parity terms), up from 23.2% in 2010 A critical question for Asia’s manufacturing and PE industries is whether the rise in Asian demand can offset the sluggish growth in developed Western markets China’s merchandise exports to Europe fell 7.5% month-on-month in September 2011 and 9% in October 2011 while its total exports declined by 7.2% in that month China’s purchasing manager’s index, a proxy for manufacturing sector performance, declined for the first time in three years in November 2011, registering a sub-50 reading, denoting a contraction in factory activity It stayed below 50 in December 2011 and January 2012 Meanwhile, the crisis in the euro zone countries and the slow recovery in the US significantly raise the risk of a global Figure 6: Private consumption (% real growth p.a.) 10 China Euro Area (AGG) India Indonesia Singapore US 2015 2016 -2 2010 2011 2012 2013 2014 Source: Economist Intelligence Unit 12 EDB_Engineering_main.indd 12 © The Economist Intelligence Unit Limited 2012 3/6/2012 8:40:32 AM Asia Competition Barometer: Precision engineering recession, according to the EIU We estimate there is a greater than 40% chance that the global economy will fall into recession sometime in the next two years Nevertheless, our core forecast assumes that private consumption in Asia, particularly China, will continue growing strongly (see Figure 6) Still, it remains to be seen if that growth will be able to offset the likely slowdown in demand in the West over the next few years There is also a risk across many sectors in Asia, from real estate to shipbuilding, of an overinvestment in capacity over the past few years If manufacturers have similarly overinvested in PE machinery, the PE industry may have to contend with several years of slow growth While still vulnerable to a slowdown in the West, Asia’s PE industry has become increasingly dependent on rising private consumption in the region If Asia’s economies should stumble—hurting employment and income growth—that would have a negative impact on the region’s PE industry, as consumers are likely to quickly cut back on discretionary purchases, such as new mobile phones and better cars Semiconductors and solar: Asian growth stories The growing demand for personal computers, mobile phones, tablets and other consumer electronics in Asia has been a major driver of the semiconductor market Asia ex-Japan’s share of global semiconductor sales increased from about 40% in 2004 to more than 50% in 2009, according to the Semiconductor Industry Association, highlighting the growing importance of Asia to this segment of the PE industry.7 In 2010, the global semiconductor market grew by US$72bn or 31.8%, with Asia accounting for more than half of that growth (sales in the region increased by US$40.4bn to US$160bn) Despite the darkening global economic outlook, and the related moderation of Asia’s growth forecasts, the EIU expects the markets for consumer electronics, mobile handsets, smartphones and personal computers in Asia to grow, albeit possibly at a more gradual rate (see Figure 2) Indeed, compared to developed regions, the Figure 7: Device penetration levels penetration of these devices in Asia is still low (%) Asia & Australasia North America 150 (see Figure 7) This suggests that there is still plenty of room for 120 catch-up growth Thus the semiconductor industry 90 can expect to see continued growth in Asia and, 60 by extension, so can semiconductor equipment 30 manufacturers Asia has become the most important market for companies in this space Mobile subs (per 100) Additionally, semiconductor manufacturers Source: Economist Intelligence Unit relentlessly invest in new technology in order to lower the unit costs of processing power “Consumer end-demand for electronics, most recently in smartphones and tablet computers, has historically driven competition in our industry to make faster, more complex, and cheaper semiconductors in line with Moore’s law,” says Mr Tham at Applied Materials.8 He cites the iPod as an example An iPod built in the 1970s at the cost-per-transistor then would have cost US$3.2bn and would have been the size of a house; however, with innovation in line with Moore’s law, today an iPod costs US$250 and fits into a pocket © The Economist Intelligence Unit Limited 2012 EDB_Engineering_main.indd 13 Global Sales Report Semiconductor Industry Association Various years West Europe World PCs (per 100) Moore’s law is named after Gordon Moore, co-founder of Intel, a computer chip manufacturer, who predicted that computer processing power—measured by the number of transistors on an integrated circuit—would rise exponentially, doubling every 18 months or so 13 3/6/2012 8:40:32 AM Asia Competition Barometer: Precision engineering What is true here of semiconductors is also true of solar panels, says Mr Tham “As the industry reduces the cost-per-watt resulting in cheaper solar panels, competition will drive price pressures and potentially result in consolidation,” he says Despite the recent hiccups in the industry, Mr Tham expects solar energy to become a viable alternate energy source “Innovations by PE companies create manufacturing solutions that help PV producers push down the cost-per-watt, and will eventually make solar energy cost competitive with traditional energy sources.” In Mr Tham’s view, most global players have acknowledged the importance of Asia as an important semiconductor and solar manufacturing base and there is “an emerging preference of the industry to have a larger and more significant presence in Asia” 14 EDB_Engineering_main.indd 14 © The Economist Intelligence Unit Limited 2012 3/6/2012 8:40:33 AM Asia Competition Barometer: Precision engineering Case Study: Applied Materials Applied Materials: Continued growth in Asia Applied Materials, with revenues of more than US$10bn in 2011, is the world’s largest supplier of manufacturing equipment and services for the semiconductor, flat-panel display and solar industries “About 75% of our revenue comes from Asia, up from about 50% a decade ago We have a significant presence throughout Asia in China, Taiwan, Singapore, India, Japan and South Korea, and are continuing to grow our footprint in the region,” says Russell Tham, regional president of Applied Materials South East Asia Since establishing itself in Asia more than 20 years ago with sales and technical support functions, Mr Tham says that the company has added “strategic and operational roles to cater to a market base that is shifting to Asia, and to improve cost competitiveness.” “Competition to keep up with Moore’s Law, which drives increasingly advanced semiconductors, has resulted in a trend of consolidation for our semiconductor manufacturing customers, as well as ever increasing capital investment required to achieve the profitable economies of scale,” Mr Tham says, in explaining the high investment barriers involved in the semiconductor industry © The Economist Intelligence Unit Limited 2012 EDB_Engineering_main.indd 15 He believes the PE sector itself is increasingly capital intensive, particularly with the development of technologies such as threedimensional integrated circuits, which require “significant RD&E [research, development and engineering] resources and investment that are only available to global players.” Mr Tham suggests that competition-driven consolidation among the PE industry’s customers could lead to a similar consolidation in the PE industry itself In May 2011, Applied Materials acquired Varian Semiconductor for US$4.9bn and in November 2009, it paid approximately US$364m to buy Semitool, another semiconductor company Similarly, wafer fabrication equipment supplier Lam Research agreed to buy rival Novellus Systems for US$3.3bn in December 2011 To gain a competitive advantage, says Mr Tham, PE companies will have to invest in R&D “to address an increasing number of technology inflection points in order to enable Moore’s law and produce newer technologies at ever cheaper costs.” He adds that these innovations will involve new materials, unique integrated circuit design architectures, novel patterning structures and larger substrates “The trend of globalisation has also seen companies optimise their global footprint through the development of lower cost operations and supply chains, especially in Asia,” he adds 15 3/6/2012 8:40:33 AM Asia Competition Barometer: Precision engineering Outlook O ver the past decade, Asia’s PE industry has expanded in tandem with the region’s manufacturing sector The number and size of Asian PE companies has increased, while many have broadened the scope of their operations by entering new segments as well as by integrating vertically Several Asian companies recorded large increases in their operating revenues between 2004 and 2009 For instance, the annual turnover of Larsen & Toubro, an Indian technology, engineering, manufacturing and construction firm, increased from US$3.4bn in 2004 to US$9.5bn in 2009 For the industry as a whole, after a slight dip in profitability in 2005-06, margins have risen steadily In particular, big companies have been able to exploit economies of scale and grow rapidly, both organically and through mergers and acquisitions With ongoing consolidation in the industry, it seems likely that the bigger firms will continue to grow their market share The industry’s outlook over the next few years hinges largely on two trends—the merging of Asian and non-Asian PE business models; and the shift in demand from the West to the East First, as Asia’s market has grown, more non-Asian global players have entered the region “Over the next few years, the Asian firms and non-Asian firms will compete with each other in terms of price and technology competitiveness, cost control and production efficiency,” Mr Shao at World Precision Machinery says Therefore, even as Asia’s largest PE firms are winning market share from smaller Asian players, they increasingly have to contend with non-Asian giants who are lowering their costs of production and broadening their footprints across the region The industry is thus likely to be characterised by fierce competition between big Asian and non-Asian players, who may increasingly resemble one another Second, Asian manufacturers—and, by extension, the PE firms they depend on—are seeing a demand shift from developed Western markets to the emerging world, particularly Asia Rising disposable incomes in the region have driven exponential growth in the markets for a range of consumer products, from automobiles to tablet computers Asian PE firms are becoming increasingly dependent on these booming Asian markets for their growth Their success over the next few years will depend on how accurately 16 EDB_Engineering_main.indd 16 © The Economist Intelligence Unit Limited 2012 3/6/2012 8:40:33 AM Asia Competition Barometer: Precision engineering they have planned for and managed this shift, particularly given the broader global macroeconomic uncertainty Over the longer term, Asia’s secular growth story will ensure that its PE industry continues to grow rapidly © The Economist Intelligence Unit Limited 2012 EDB_Engineering_main.indd 17 17 3/6/2012 8:40:33 AM Asia Competition Barometer: Precision engineering Barometer methodology T o assess the intensity of competition and understand the changing market dynamics in key sectors, the Economist Intelligence Unit has developed the Asia Competition Barometer Drawing upon companylevel data on profitability and other indicators, the Barometer quantifies the changing dynamics of competitiveness in Asia for select industries between 2004 and 2009 Assessing a universe of over 200 publicly-listed precision engineering (PE) companies across eight countries—China, India, Indonesia, Malaysia, the Philippines, Singapore, Thailand and Vietnam—the Barometer examines changing profitability and the competition landscape for the PE sector How we define the precision engineering sector? The PE sector includes the manufacture of: Instruments and appliances for measuring, testing and navigation, irradiation, electromedical and electrotherapeutic equipment, optical instruments and photographic equipment, power-driven hand tools, metal-forming machinery, other machine tools, other special-purpose machinery, air and spacecraft and related machinery and medical and dental equipment and supplies Methodology The Barometer has two dimensions: profitability and market concentration Profitability Index To assess the aggregate profitability of the PE in Asia, the Economist Intelligence Unit developed a composite index of five ratios that each represent a different aspect of a company’s profitability: • EBITDA margin (%): A measure of a company’s operating profitability It is equal to earnings before interest, tax, depreciation and amortisation (EBITDA) divided by total revenue Because EBITDA 18 EDB_Engineering_main.indd 18 © The Economist Intelligence Unit Limited 2012 3/6/2012 8:40:33 AM Asia Competition Barometer: Precision engineering excludes depreciation and amortisation, EBITDA margin provides a clearer view of a company’s core profitability An increase in competition may put pressure on an industry’s profit margins • Gross margin (%): When used as a market measure of competition, gross margin measures the profitability considering only the costs of goods sold The higher the percentage, the more the company retains on each dollar of sales to service its other costs and obligations An increase in competition tends to reduce firms’ ability to increase prices and thereby increase its gross margin • Return on capital employed (%): A measure of the efficiency and profitability of a company’s capital investments Return on capital employed also indicates whether the company is earning sufficient revenues and profits in order to make the best use of its capital assets An increase in competition may require firms to employ additional capital to maintain profitability • Return on equity (%): A measure of the rate of return on the shareholders’ equity It measures a firm’s efficiency at generating profits from every unit of shareholders’ equity Return on equity shows how well a company uses shareholder funds to generate earnings growth A rise in competition tends to put pressure on returns on shareholder funds • Return on assets (%): A measure of how profitable a company’s assets are in generating revenue, or how profitable a company is relative to its assets Return on assets determines a company’s ability to utilise its assets efficiently and effectively Higher competition tends to put pressure on firms’ ability to maintain return on assets We aggregated company-level data for more than 200 publicly-quoted PE companies and examined their profitability ratios To enable observation of trends over time, a composite Profitability Index was developed (where year 2005 = 100) EBITDA and gross margin are given a higher weighting in the index as they speak directly to bottom line profitability, while the return on capital employed, return on equity and return on assets ratios speak to how a company make use of its various resources to drive return (i.e efficiency/ productivity) Profitability indicator Weight in Profitability Index EBITDA margin (%) 35% Gross margin (%) 35% Return on capital employed (%) 10% Return on equity (%) 10% Return on assets (%) 10% Market concentration To assess market concentration, the Economist Intelligence Unit calculated the Herfindahl-Hirschmann Index (HHI) for the PE sector in Asia from 2004 to 2009 A measure of the size of companies in relation to the industry, and an indicator of the amount of competition among them, the HHI is defined as the sum of the squares of the market shares of the 50 largest firms from the universe of over 200 listed companies assessed.9 HHI values can range from to 1.0, moving from an extremely fragmented market (0) to a © The Economist Intelligence Unit Limited 2012 EDB_Engineering_main.indd 19 Or summed for all the firms in the case that there are fewer than 50 19 3/6/2012 8:40:33 AM Asia Competition Barometer: Precision engineering monopoly (1) HHI values have been multiplied by 100 to achieve a scale consistent with profitability indicators A rising HHI index generally indicates falling market competition, while a fall in the HHI suggests that competition is increasing 20 EDB_Engineering_main.indd 20 © The Economist Intelligence Unit Limited 2012 3/6/2012 8:40:33 AM Whilst every effort has been taken to verify the accuracy of this information, neither The Economist Intelligence Unit Ltd nor the sponsor of this report can accept any responsibility or liability for reliance by any person on this report or any of the information, opinions or conclusions set out herein [...]... AM Asia Competition Barometer: Precision engineering they have planned for and managed this shift, particularly given the broader global macroeconomic uncertainty Over the longer term, Asia s secular growth story will ensure that its PE industry continues to grow rapidly © The Economist Intelligence Unit Limited 2012 EDB _Engineering_ main.indd 17 17 3/6/2012 8:40:33 AM Asia Competition Barometer: Precision. .. cities, Danyang and Shanghai 11 3/6/2012 8:40:32 AM Asia Competition Barometer: Precision engineering Positioning for success in Asia Sustained growth in Asia G iven the long-term structural problems in many Western markets and emerging Asia s largely bullish economic fundamentals, the shift in trade and investment from the West to Asia will continue Asia s economic growth is expected to continue outpacing... produce newer technologies at cheaper costs 10 EDB _Engineering_ main.indd 10 © The Economist Intelligence Unit Limited 2012 3/6/2012 8:40:32 AM Asia Competition Barometer: Precision engineering Case Study: World Precision Machinery World Precision Machinery: Moving up the technology ladder World Precision Machinery (WPM), an integrated manufacturer of precision metal stamping machines based in Jiangsu,... especially in Asia, ” he adds 15 3/6/2012 8:40:33 AM Asia Competition Barometer: Precision engineering Outlook O ver the past decade, Asia s PE industry has expanded in tandem with the region’s manufacturing sector The number and size of Asian PE companies has increased, while many have broadened the scope of their operations by entering new segments as well as by integrating vertically Several Asian companies... importance of Asia as an important semiconductor and solar manufacturing base and there is “an emerging preference of the industry to have a larger and more significant presence in Asia 14 EDB _Engineering_ main.indd 14 © The Economist Intelligence Unit Limited 2012 3/6/2012 8:40:33 AM Asia Competition Barometer: Precision engineering Case Study: Applied Materials Applied Materials: Continued growth in Asia. .. Competition Barometer: Precision engineering Barometer methodology T o assess the intensity of competition and understand the changing market dynamics in key sectors, the Economist Intelligence Unit has developed the Asia Competition Barometer Drawing upon companylevel data on profitability and other indicators, the Barometer quantifies the changing dynamics of competitiveness in Asia for select industries... EBITDA 18 EDB _Engineering_ main.indd 18 © The Economist Intelligence Unit Limited 2012 3/6/2012 8:40:33 AM Asia Competition Barometer: Precision engineering excludes depreciation and amortisation, EBITDA margin provides a clearer view of a company’s core profitability An increase in competition may put pressure on an industry’s profit margins • Gross margin (%): When used as a market measure of competition, ... 2012 EDB _Engineering_ main.indd 19 9 Or summed for all the firms in the case that there are fewer than 50 19 3/6/2012 8:40:33 AM Asia Competition Barometer: Precision engineering monopoly (1) HHI values have been multiplied by 100 to achieve a scale consistent with profitability indicators A rising HHI index generally indicates falling market competition, while a fall in the HHI suggests that competition. .. merging of Asian and non-Asian PE business models; and the shift in demand from the West to the East First, as Asia s market has grown, more non-Asian global players have entered the region “Over the next few years, the Asian firms and non-Asian firms will compete with each other in terms of price and technology competitiveness, cost control and production efficiency,” Mr Shao at World Precision Machinery... even as Asia s largest PE firms are winning market share from smaller Asian players, they increasingly have to contend with non-Asian giants who are lowering their costs of production and broadening their footprints across the region The industry is thus likely to be characterised by fierce competition between big Asian and non-Asian players, who may increasingly resemble one another Second, Asian manufacturers—and, ... AM Asia Competition Barometer: Precision engineering Preface Supported by Singapore’s Economic Development Board (EDB), the Economist Intelligence Unit has developed the Asia Competition Barometer. .. 3/6/2012 8:40:31 AM Asia Competition Barometer: Precision engineering Competition and profitability at Asian firms T he number and size of publicly-listed firms in the PE sector in Asia has increased... EDB _Engineering_ main.indd 10 © The Economist Intelligence Unit Limited 2012 3/6/2012 8:40:32 AM Asia Competition Barometer: Precision engineering Case Study: World Precision Machinery World Precision