Industry Analysis: Capital Goods Industry Executive Summary Capital goods is a mature industry with a unique opportunity for expansion and growth in the developing markets. While large, diversified conglomerates – the major industry players – have saturated developed markets, population and city growth in developing markets have increased demand for food, natural resources, and infrastructure, thereby growing the demand for capital goods, with over 8. 1% growth per year projected over the next 5 years.
Companies currently outside the industry face high barriers to entry, making it unattractive for new entrants, and creating a strong competitive environment for the relatively small number of large and current industry players. Individual companies dominate specific sectors of the capital goods market. Rivalry is high, as there is relatively little product diversity within the sector, and firms’ primary opportunity for differentiation is on technological expertise and value-add offerings such as warranties and service. Given these challenges, acquisition is the best growth strategy.
With over 250 mergers and acquisitions over the past 3 years, the capital goods markets is rapidly consolidating as large players gain more market share. In addition, acquisitions allow these large conglomerates to enter emerging markets where the long-term future growth exists. In conclusion, capital goods is a moderately attractive industry because of these opportunities for growth. ? The capital goods industry is extremely broad and comprises two major categories: engines and global machinery, which includes agricultural, construction, and mining machinery (Exhibit 1). The global machinery industry is valued at $182. billion , while engines adds another $12. 8 billion , representing a total capital goods value of $195. 2 billion. Within the global machinery market, construction and industrial equipment comprise the largest share, with 46. 3% of market revenues ($84. 5b). The construction segment includes earthmoving, road, and concrete equipment. Agricultural equipment makes up 30. 8% ($56. 1b) of market revenues, with products such as compact tractors, hay balers and combine harvesters. Mining is the smallest part of the global machinery segment; equipment such as crushing, pulverizing and screening machinery, portable drilling rigs and parts, and lants and drills make up 22. 9% of the market. Engines (stationary, non-utility power generators) comprise a much smaller part of capital goods, at 6. 6% of the total capital goods market revenue. The total 2010 market revenue stands at $12. 8 billion. Capital goods is a mature industry in a high-capital business that is subject to the ebb and flow of the agricultural, construction, and mining business cycles. Subsequently, the major players are large, well-established conglomerates that have diversified across a number of capital goods industries to mitigate the risks associated with this cycle (Exhibit 2).
Many of these companies also have expanded into financing to provide additional services to customers. The capital goods industry is also, not surprisingly, positively correlated with the overall market economy (Exhibit 3), and the recent recession has affected overall profit margins. (Exhibit 4) The largest players in global capital goods (and their specific GCG components) are Caterpillar (construction and mining equipment, engines), Deere & Company (agricultural equipment, construction), Hyundai Heavy Industries (engines and machinery, construction equipment), and Volvo (construction equipment, engines).
Additionally, other smaller, less diversified players also contribute to the global capital goods market, but they do not have the industry dominance of the companies above (Exhibit 5). While capital goods companies are in most countries around the world , a few large conglomerates and thousands of smaller players characterize most developed markets, and much of the growth takes places through mergers and acquisitions. However, current and projected population growth, as well as the urbanization of developing countries, presents new opportunities in developing markets (Exhibits 6 & 7). See Exhibit 8 for Environmental Analysis). While construction, agriculture, and mining are in the top 15 (but outside the top 8) of sectors contributing to increased value in developed countries, these sectors make up the top 3 sectors in growth in emerging markets (Exhibit 9). The industry is subject to the global economic business cycle and has faced tough economic conditions due to the economic crisis: the 2006-2010 CAGR for machinery and engine markets was -6. 3% in the US and -0. 4% in Europe (Exhibit 10) and the halt of capital goods projects led to a 16. % loss in revenue in 2009. However, capital goods are positioned for strong growth in the years to come. The 2010-2015 CAGR is projected to be 8. 1%, an $86. 9 billion (48%) increase in the market size. More importantly, even when developed markets were in decline in 2006-2010, the CAGR for Asia-Pacific was 8. 8%, meaning these markets kept growing despite the economic challenges. Growth for global engines is similarly positioned, with a projected 2010-2015 CAGR of 6. 4%, an anticipated increase of $17. 4 billion.
Capital goods products tend to be somewhat commoditized, but increasingly customers are looking for companies that provide technological expertise, such as enhanced productivity and improved engine efficiency, and product add-ons, including warranties and additional servicing. Large companies are best positioned to address on these customer needs, as their significant manpower, R&D budgets, intellectual property rights, and economies of scale give them the ability to address these specific needs. Additionally, more and more capital goods companies are taking their businesses online.
While on one hand, consumers now have a more transparent pricing mechanism, online ordering systems also allows capital goods customers to create more customized products – providing an opportunity for companies to differentiate in a somewhat static product marketplace. The capacity for technological improvement may also position large conglomerates to respond to national and global environmental regulations. The relatively saturated developed market means that most capital goods growth comes from mergers and acquisitions activities (Exhibit 11), which can provide distinct advantages t companies looking to further expand into developing markets. A five forces analysis of the capital goods industry demonstrates the challenges of large conglomerates operating in a mature competitive environment (Exhibit 12). High barriers to entry generally limit competitions, meaning rivalry is incredibly high within the industry, especially with declining sales. However, the growth potential of developing markets ensures new frontiers in which companies can compete. Both the supplier and buyer power within this industry are moderate.
The barriers to market entry generally restrict the entrants into the capital goods market – potential entrants have to consider the high capital investment costs required to start up and maintain the business, as well as the challenge of breaking into a market with considerable brand loyalty. The large conglomerates that dominate the sector also benefit from the learning curve, as well as economies of scale in purchasing, production, and distribution. While smaller, specialty anufactures can enter the market and find a niche position in a market with relatively homogeneous offerings, in general, the industry barriers are so challenging that there is a low threat of entry from outside competitors. While rivals may not come from outside of the industry, capital goods companies face strong competition from within. Within any one market, products are relatively unvaried, but the growth of new markets and increased product differentiation provides new opportunities for growth – thus ratcheting up company rivalry.
Additionally, high exit costs up the market share ante, spurring companies to stay in the industry. No one firm dominates the industry, although they may dominate certain segments. Rivalry for market share is also influenced by strong buyer power. Most buyers have relatively low switching costs , and large buyers have significant market power with large, multi-year orders. There is somewhat of a premium on “expertise and market reputation”, as buyers are generally making substantial investments in the equipment.
Fortunately for industry players, the potential for substitutes is extremely weak, as there are no true substitutes for the global machinery or engine industry. While there is somewhat of a market for used machinery, capital goods customers emphasize product warranty, efficiency, and overall life of a machine, which the secondary market does not provide. Market suppliers have moderate power within the capital goods industry; many inputs (steel, aluminum, electronic components) are priced as commodities, but some companies are reliant on a single supplier.
Larger companies do benefit from their network of supply chains, which provides them with economies of scale and some negotiation power. However, the industry is influenced overall by the dramatic fluctuations in the market from year to year, which can present pricing challenges. Complements may exist between products and many of the companies in the machinery business have a financial arm to expedite the transaction. Government regulation in developed countries has pushed for increasing standards for emissions and efficiency. For example in the U.
S. , the 2007 Highway Heavy-Duty Highway Rule mandated that emissions of nitrogen oxides had to be 90% lower than 2004 levels. This is reflected in other developed economies and represents an additional cost in research and development that could be a barrier to new entrants. These trends are not present in emerging markets, which allow conglomerates to sell older technology. In conclusion, the capital goods industry can be defined by a handful of large, high-revenue generating conglomerates surrounded by numerous smaller, more niche-based players.
As this industry is so highly correlated with the economy, the capital goods in the developed markets show stagnant growth. On the other hand, the emerging markets are showing significantly more growth and opportunity for this space. To better compete within both the developed and emerging markets, it is in the capital goods players’ best interest to acquire competing and more niche brands to increase their market share in the developed markets and experience high growth in the emerging markets. As a result, the capital goods market is moderately attractive for incumbents.
Exhibit 1: Capital Goods Industry ? Exhibit 2: Company Product Analysis CompanyAgriculturalConstructionElectricalEnginesMiningShipbuildingVehicle AB Volvo X X CaterpillarXX XX CNH Global N. V. XX Cummins Inc. XX Deere and CompanyXX X GE Energy Infrastructure XX Hyundai Heavy Industries XX X Joy Global Inc. X Kawasaki Heavy Industries XXX XX Komatsu Ltd X X Liebherr-International AG X XX MAN SE X XX Siemens Energy X Tognum AG X X Wartsila Corp. XX X Source: Datamonitor and Company Filings ? Exhibit 3: Dow Jones vs.
Metals and Agricultural Industries Source: Dow Jones Exhibit 5: Comparable Company Analysis Source: Yahoo. com ? Exhibit 4: Source: Bigcharts. com and www. mawev. at Exhibit 6: GDP Growth Analysis Exhibit 7: ? Exhibit 8: Environmental Analysis Demographic Trends •Population growth requires increased demand for agricultural output •Infrastructure developments in developing nations Socio-cultural Influences •Citification requires infrastructure development •More sophisticated consumer demands Macroeconomic Impacts Industry declined with economic crisis in 2008 & 2009, but now beginning to rebound •Tied to business cycle and tends to be cyclical •Commodity prices and foreign exchange affects demands and supply Political Legal Pressures •International environmental laws governing the use, transport and disposal of substances and control of emissions requires additional research and development •Economic development programs inject funding into infrastructure development •Business dependent upon local government in growing markets Technological Developments Push for more environmentally friendly products •Gains from economies of scale and synergies •New technologies and intellectual property increasing efficiency and power Global Trade Issues •With international conglomerates, sensitive to tariffs and taxes •Increasing global trade ? Exhibit 9: Industry Growth Source: Deere & Company company filings Exhibit 10: Source: Data Monitor 2011 Machinery in the US ($b), World Market Research Center 2011 Exhibit 11: Acquisitions in Capital Goods (2008-2011) Source: Capital IQ ? Exhibit 12: ?