By David Humphrey
ARC STRATEGIES
JUNE 2003
Capital Expenditure Survey 2003
Executive Overview ...............................
ARC Strategies • June 2003
2 • Copyright © ARC Advisory Group • ARCweb.com
1997 1998 1999 2000 2001 2002 CAGR
Aerospace 3....
ARC Strategies • June 2003
Copyright © ARC Advisory Group • ARCweb.com • 3
Capital spending continues to
decline in nearly...
ARC Strategies • June 2003
4 • Copyright © ARC Advisory Group • ARCweb.com
By employing open industrial
standards to surfa...
ARC Strategies • June 2003
Copyright © ARC Advisory Group • ARCweb.com • 5
Large global producers like Unilever, Procter &...
ARC Strategies • June 2003
6 • Copyright © ARC Advisory Group • ARCweb.com
their spending on improving or modernizing exis...
ARC Strategies • June 2003
Copyright © ARC Advisory Group • ARCweb.com • 7
The New Focus Is on Operational Strategies
Most...
ARC Strategies • June 2003
8 • Copyright © ARC Advisory Group • ARCweb.com
Economic Outlook for CapEx
Capital spending tre...
ARC Strategies • June 2003
Copyright © ARC Advisory Group • ARCweb.com • 9
The final shock to Germany will come
in 2004 wh...
ARC Strategies • June 2003
10 • Copyright © ARC Advisory Group • ARCweb.com
In automotive, premium manufacturers are still...
ARC Strategies • June 2003
Copyright © ARC Advisory Group • ARCweb.com • 11
Capital spending as a percentage of reve-
nue ...
ARC Strategies • June 2003
12 • Copyright © ARC Advisory Group • ARCweb.com
In Europe, premium brands like BMW and Porsche...
ARC Strategies • June 2003
Copyright © ARC Advisory Group • ARCweb.com • 13
stage. Consequently, the design of efficient, ...
ARC Strategies • June 2003
14 • Copyright © ARC Advisory Group • ARCweb.com
Food & beverage manufacturers continue to focu...
ARC Strategies • June 2003
Copyright © ARC Advisory Group • ARCweb.com • 15
Challenges in upstream include managing
oil an...
ARC Strategies • June 2003
16 • Copyright © ARC Advisory Group • ARCweb.com
of the EU Good Manufacturing Practice, Data Pr...
ARC Strategies • June 2003
Copyright © ARC Advisory Group • ARCweb.com • 17
imports from Asia. Rather than build new paper...
ARC Strategies • June 2003
18 • Copyright © ARC Advisory Group • ARCweb.com
widely. Newly privatized energy
companies are ...
ARC Strategies • June 2003
Copyright © ARC Advisory Group • ARCweb.com • 19
Analyst: David W. Humphrey
Editors: Dick Hill,...
3 ALLIED DRIVE DEDHAM MA 02026 USA 781-471-1000
BOSTON, MA | PITTSBURGH, PA | PHOENIX, AZ | SAN FRANCISCO, CA
CAMBRIDGE, U...
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Capital Expenditure Survey 2003

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Capital Expenditure Survey 2003
Capital spending continues to decline in nearly all industries, continuing a
trend that began in the mid-1990s when manufacturing productivity began
to increase markedly. The continuing uncertainty in most economies has
put pressure on manufacturers to cut spending, resulting in a steady decline
for several years now despite increasing revenues. Helping to fuel the
cost-cutting fire are the mega-mergers between industrial giants that have
racked up billions in savings as companies increase their manufacturing
economies of scale and eliminate duplicate functions.
ARC’s CapEx index tracks capital expenditures, total revenue, total assets,
EBIT, and return on assets (ROA) for 56 companies in 10 target industries,
representing $2.4 trillion in annual revenue. Companies in the index
generate revenue from most global markets and many
spread their manufacturing around the globe. Of the 56
companies, 64 percent have their headquarters in North
America, 27 percent in Europe, and 9 percent in Asia.

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Capital Expenditure Survey 2003

  1. 1. By David Humphrey ARC STRATEGIES JUNE 2003 Capital Expenditure Survey 2003 Executive Overview .................................................................... 3 Capital Spending Decline Continues............................................... 3 Economic Outlook for CapEx ........................................................ 8 CapEx Trends by Industry...........................................................10 Recommendations .....................................................................18 THOUGHT LEADERS FOR MANUFACTURING & SUPPLY CHAIN
  2. 2. ARC Strategies • June 2003 2 • Copyright © ARC Advisory Group • ARCweb.com 1997 1998 1999 2000 2001 2002 CAGR Aerospace 3.8% 3.6% 3.1% 3.0% 3.5% 3.5% -1.4% Automotive 5.9% 6.0% 5.7% 5.7% 5.5% 5.1% -2.8% Chemicals 7.9% 9.6% 8.7% 7.9% 7.6% 7.1% -2.2% Food & Beverage 4.5% 4.3% 4.3% 4.3% 4.1% 3.7% -4.0% Metals 8.6% 9.2% 8.9% 8.3% 6.8% 5.9% -7.4% Oil & Gas 7.1% 8.7% 7.5% 4.4% 6.2% 6.0% -3.4% Pharmaceutical 5.7% 6.4% 6.6% 6.1% 6.1% 5.6% -0.3% Pulp & Paper 7.0% 6.1% 4.8% 5.0% 4.7% 4.4% -8.7% Semiconductor 12.0% 11.1% 9.7% 12.9% 16.4% 12.8% 1.3% Utilities 17.3% 16.3% 17.1% 18.1% 19.8% 17.6% 0.4% All Industries 7.0% 7.4% 6.5% 6.0% 6.7% 6.1% -2.9% Capital Expenditures as a Percentage of Revenue by Industry All Industries (1997 = 100) 86 120 137 80 90 100 110 120 130 140 1997 1998 1999 2000 2001 2002 CapEx/Revenue Revenue Assets CapEx/Revenue vs. Total Revenue and Total Assets
  3. 3. ARC Strategies • June 2003 Copyright © ARC Advisory Group • ARCweb.com • 3 Capital spending continues to decline in nearly all industries, continuing a trend that began in the mid-1990s when manufacturing productivity began to increase markedly. Executive Overview Capital spending continues to decline in nearly all industries, continuing a trend that began in the mid-1990s when manufacturing productivity began to increase markedly. The continuing uncertainty in most economies has put pressure on manufacturers to cut spending, resulting in a steady de- cline for several years now despite increasing revenues. Helping to fuel the cost-cutting fire are the mega-mergers between industrial giants that have racked up billions in savings as companies increase their manufacturing economies of scale and eliminate duplicate functions. ARC’s CapEx index tracks capital expenditures, total revenue, total assets, EBIT, and return on assets (ROA) for 56 companies in 10 target industries, representing $2.4 trillion in annual revenue. Companies in the index generate revenue from most global markets and many spread their manufacturing around the globe. Of the 56 companies, 64 percent have their headquarters in North America, 27 percent in Europe, and 9 percent in Asia. According to ARC’s most recent data, capital spending as a percentage of revenue across all ten target industries has declined at a compounded annual rate of -2.9 percent since 1997. This decline in spending has occurred despite an annual growth in revenues averaging 3.7 percent and in total assets averaging 6.5 percent during the same period. Revenue, spending and asset figures in the ARC CapEx index changed in part due to acquisitions and divestitures made during the 6-year period, so the indictor used here is capital spending ver- sus revenue. Even with these gains and losses, absolute capital spending grew only by 0.7 percent annually. Capital Spending Decline Continues Industrial capital spending remained stubbornly flat in 2002, held back primarily by geopolitical instability that dampened consumer spending and weighed down nearly all the world’s major economies. To rescue the bot- tom line, manufacturers cut back production, closed plants, reduced spending and shed employees in record numbers. IT spending in particu- lar was hit hard for the second year in a row. Many manufacturers now
  4. 4. ARC Strategies • June 2003 4 • Copyright © ARC Advisory Group • ARCweb.com By employing open industrial standards to surface information above the controls level, CDAS and CPAS architectures let manufacturers focus more on meeting business objectives and less on integrating dissimilar technologies. feel they have their IT infrastructures in place and see only marginal bene- fits in additional investments versus the “leaps and bounds” perception of the Internet boom. Why Do Manufacturers Continue to Spend Less? As the world waits for signs of an economic recovery, many of the same trends in capital spending continue to plague suppliers, although all indus- tries vary slightly. The most significant reasons are summarized below. Mergers Create Need for Collaborative Architectures The urge to merge is continuing to consolidate manufacturing across many industries, especially food & beverage, pharmaceutical, oil & gas and pulp & paper. Manufacturers are acquiring or merging with other players to increase their critical mass and diversify their product portfolios in increas- ingly competitive global markets. While a merger may produce long-term benefits, it also tends to distract a company’s attention in the short-term as business systems are integrated, sales forces are united and product portfo- lios are rationalized. Capital budgets are shifted temporarily to internal integration efforts and ultimately are trimmed to reflect the newly won effi- ciencies of the resulting conglomerate. The direct benefits for manufacturers are increased operating efficiencies and reduced costs due to the elimination of duplicate functions and the more flexible use of manufac- turing assets. Savings can be substantial: General Mills expects to save $350 million in 2003 and $475 million more in 2004 through its merger with Pillsbury. Oil mega-mergers like ChevronTexaco and ExxonMobil each claim savings of over $1 billion per year since the merger. Some mergers are bearing fruit by creating greater economies of scale while increasing manufacturing capacity. However, real synergies can only be achieved if the additional capacity is exploited through flexible manufacturing that enable produc- tion facilities to respond more quickly to changes in market demand. For example, a South American brewer recently responded to a sudden increase in demand for light beer caused by the introduction of a competitor’s product. Although the capacity to produce the new light beer existed, the brewer found that the recipes were hard-coded in his automation systems, turning a simple product changeover into a lengthy and costly project.
  5. 5. ARC Strategies • June 2003 Copyright © ARC Advisory Group • ARCweb.com • 5 Large global producers like Unilever, Procter & Gamble, Nestle and South African Breweries are constantly faced with the challenge of working with dissimilar control systems brought together through corporate acquisitions. Rather than standardizing control system components worldwide, many are turning to new architectures like CDAS and CPAS (see ARC Strategy Reports “Collaboration Discrete Automation Systems Define the Factory of the Future”, May 2003 and “Collaboration Process Automation Systems Drive Return on Assets”, June 2002). CDAS and CPAS architectures are based on standards like the ISA S95 Manufacturing Model to increase in- formation visibility by synchronizing and managing cross-functional processes across all manufacturing domains. By employing open industrial standards to surface information above the controls level, manufacturers can focus more on meeting business objectives and less on integrating dis- similar technologies. Strategic Outsourcing Continues Outsourcing just shifts capital investments from one asset-owner to an- other, but the reality is that outsourcing allows assets to be used much more efficiently by an owner with a narrower focus, a broader market for the as- set, and a larger incentive to maximize the return on assets. The final frontier of outsourcing, contract manufacturing, has been a huge success in the electronics industry for years. Now, the outsourcing of manufacturing is starting to appear in other industries including automotive and even food & beverage as more and more companies remove manufacturing from their list of core competencies, focusing instead on product design and market- ing. ARC expects manufacturing outsourcing to increase while outsourcing in traditional areas like maintenance and project services continues to grow. Under-Capacity Keeps Manufacturers in “Improvement Mode” Manufacturers’ spending behavior can be classified into two categories: 1) “improvement mode” spending that focuses on optimizing processes to squeeze more performance from existing assets when demand is down, and 2) “expansion mode” spending that creates new capacity to meet rising demand. Good predictors of capital spending behavior are the US and European government statistic covering capacity utilization for the manu- facturing industries. The magic line for capacity utilization lies at around 82 or 83 percent. Below this level (presently the case in the US and Europe) manufacturers are not fully utilizing their assets, so they lie low and focus
  6. 6. ARC Strategies • June 2003 6 • Copyright © ARC Advisory Group • ARCweb.com their spending on improving or modernizing existing processes. Once ca- pacity utilization climbs through the “low 80s”, manufacturers switch modes and begin investing in capacity expansion to meet rising demand. 0 10 20 30 40 50 60 70 80 90 100 1972 1982 1992 2002 0 20 40 60 80 100 120 140 Capacity Utilization Industrial Production Capacity Utilization in the US Remains Below the Level at Which Manufacturers Traditionally Switch to Expansion Spending (Source: US Federal Reserve) In the US, capacity utilization is currently at about 74 percent, suggesting that few industries are willing to invest in increasing capacity at this time. Evidence of this is the continued drop in factory jobs in 2003 despite signs of a possible turn around later in the year. In Europe, the figures for both the European Union and the Euro Zone have dropped from about 84 per- cent in 2000 to a flat 80 percent at present, despite a brief recovery in 2002. 0 10 20 30 40 50 60 70 80 90 100 1998 1999 2000 2001 2002 2003 USA European Union Capacity Utilization in Europe Hasn’t Fallen as Quickly as in the US, But Still Remains Below the Spending Trigger Level in Most Industries (Sources: US Federal Reserve and Eurostat)
  7. 7. ARC Strategies • June 2003 Copyright © ARC Advisory Group • ARCweb.com • 7 The New Focus Is on Operational Strategies Most manufacturers have their IT systems up and running and are now focusing on achieve the efficiencies gains promised by IT investments. Manufacturers invested huge sums in IT infrastructures during the spend- ing boom that ended in 2001. In addition to hardware investments in PCs, servers and networks, most companies went through long-term supply chain management and ERP deployments that touched every area of busi- ness from raw materials sourcing to sale of goods to after sales support. Now that those systems are in place, companies are looking to reap the benefits of their investments. RPM Performance OpX Execution CMM Strategy RPM, OpX, and CMM Strategies Help Manufacturers Focus on Consistently Doing the Right Things Well ARC has identified three emerging approaches that are helping manufac- turers find ways to squeeze the maximum value out of existing assets. Collaborative Manufacturing Management (CMM) provides the strategy and flexible infrastructure required for future dynamic businesses to sur- vive. Operation Excellence (OpX) defines an execution method for continuously improving business and manufacturing processes. Finally Real-time Performance Management (RPM) combines the requirements of financial performance with monitoring and controlling KPIs in real-time. Faced with falling demand and lower sales revenue, these three strategies help manufacturers lean out manufacturing processes, better utilize exist- ing assets, and shorten return time on capital investments. The result is that manufacturers are spending their capital budgets with more discretion and selectivity in the face of both IT investment saturation and supply overcapacity.
  8. 8. ARC Strategies • June 2003 8 • Copyright © ARC Advisory Group • ARCweb.com Economic Outlook for CapEx Capital spending trends are highly susceptible to both global and local eco- nomic influences. At present, a variety of factors are influencing companies’ decisions as to how and where to invest. Despite the globaliza- tion of economies, not all are in synch with each other, and not all offer the same economic opportunities. Many companies are looking for ways to spread their investments around the globe to get closer to their customers while taking advantage of cheaper manufacturing locations. The Americas Recent indicators have started pointing to a turnaround in North America. However, hopes were raised several times in 2002, only to be dashed shortly thereafter by new shocks to the system like the Iraq war and the SARS outbreak. But just as several threats ganged up to delay the recovery last year, the picture of a recovery is now beginning to emerge – corporate profits are returning, balance sheets are healthier, free cash flow is up, in- vestor uncertainty is falling, and capacity utilization is climbing. In many cases, investments simply have been postponed rather than cancelled. However, manufacturers know they have to spend money to make money, so an improved climate in the latter half of 2003 could spur on the long awaited recovery. With interest rates at an all-time low, there is a risk in North America that a recovery may result from consumers spending against their home equity, rather than by increases in industrial spending. The leading consumers of process automation products and ser- vices in North America are the chemical and electric power industries. This trend will continue throughout 2007, but these industries will still lag slightly behind the overall market average for growth. As a subset of chemicals, fine and specialty chemicals will ex- perience above average growth. Pharmaceutical and food & beverage continue to be the growth leaders in North America and the rest of the world. Primary drivers for both of these industries are FDA regulations such as 21 CFR part 11 and adoption of more advanced automation archi- tectures. Other industries that will experience high growth through 2007 include oil & gas and water & waste. While refining continues to be in a slump, companies are still investing in exploration and production. Pulp & paper opportunities remain limited and growth will be the lowest for all of Regional OutlookRegional Outlook
  9. 9. ARC Strategies • June 2003 Copyright © ARC Advisory Group • ARCweb.com • 9 The final shock to Germany will come in 2004 when the European Union admits 10 new member countries on Germany’s eastern doorstep. The resulting net loss in manufacturing jobs not just in Germany but in all of Western Europe could dampen GDP growth for years to come. the major verticals through 2007. Industries that will experience the least growth through 2007 aside from pulp & paper include refining, bulk chemical, metals and mining (particularly steel), and cement and glass. Latin American economies are largely dependent upon the economic health of Brazil. Argentina’s economy is strongly intertwined with Brazil, result- ing in a domino effect in this region. Venezuela’s economy has been in a shambles as a result of the worldwide depression in oil prices and the re- sulting domestic instability. Latin American markets should see a modest recovery in 2003, although growth in Brazil and Argentina will not be much more than 2 percent. Europe Anemic growth and high unemployment have plagued the European economies recently. GDP growth in the 15 member countries of the Euro- pean Union may reach an unimpressive 1 percent in 2003 and will likely climb to around 2 percent in 2004. If the depreciation of the dollar against the euro persists, the competitiveness of European manufacturers will suf- fer while cheap imports flood the European market, putting Europe at a risk of deflation. Lower productivity in Europe has prevented econo- mies here from achieving the heady GDP growth rates of 3 or 4 percent common in North America. Part of the blame lies with Germany. Once the economic motor of Europe, Germany’s GDP has grown at only 1.1 percent annually since 1996 – half the rate for the rest of Europe. In a country hobbled by strict industry regula- tions and unwilling to undergo major economic reforms, companies have become more reluctant to in- vest there at a time when Central and Eastern Europe offer more lucrative opportunities. The final shock to this industrial giant will come in 2004 when the European Union admits 10 new member countries on Germany’s eastern doorstep. The resulting net loss in manufacturing jobs not just in Germany but in all of Western Europe could dampen GDP growth for years to come. Central and Eastern Europe and Russia will continue to experience steady growth of 3 to 4 percent, spurred on by the prospect of EU membership as of 2004 (not Russia) and possible future membership in the Euro common currency.
  10. 10. ARC Strategies • June 2003 10 • Copyright © ARC Advisory Group • ARCweb.com In automotive, premium manufacturers are still performing well but are turning the corner at the peak, while mass producers are feeling the pinch earlier. Especially for large European producers like VW and Daimler- Chrysler, the financial picture is deceptive - booming business in China is making the European manufacturers' numbers look rosier than they really are. While this helps spread the risk for European producers, it also masks the difficulties in the home markets. It is, however, good news for Euro- pean-based automation product and service suppliers that already have a foot in the booming Chinese market. Asia/Pacific Asian markets will continue to enjoy healthy, sustained growth with GDPs growing at 4 to 6 percent. China will again be the motor of the Asian economies with growth at least matching the 2002 level of 9 percent. In- dia‘s economy has grown more slowly, dropping below 5 percent last year, but will likely pick up in the next five years. Japan’s economy will con- tinue to remain flat due to sluggish domestic demand. Major factors contributing to this growth include the increase in the amount of disposable income in the hands of large, increasingly affluent popula- tions, large investments in infrastructure and construction projects, and massive inflow of capital to set up manufacturing facilities in industries such as automotive, electric power, cement, chemicals, oil & gas, steel and textiles. CapEx Trends by Industry Aerospace The aerospace industry has been in absolute turmoil since the terrorist at- tacks in the US in 2001 ground the worldwide airline industry to a halt. The overall demand for commercial aircraft has plummeted. Boeing, the world’s largest producer of commercial airplanes, cut its output by more than half and laid off tens of thousands of workers in 2002. The industry is seeking alternative automation strategies to keep costs down while increas- ing flexibility. Outsourcing production of non-key components is benefiting aerospace subcontractors.
  11. 11. ARC Strategies • June 2003 Copyright © ARC Advisory Group • ARCweb.com • 11 Capital spending as a percentage of reve- nue decreased insignificantly as revenues rose at a steady 3.4 percent annually, ac- cording to ARC’s CapEx index. However, eroding profits have reduced the indus- try’s ROA somewhat during the same period. Automotive Heavy discounting and zero percent fi- nancing in 2002 boosted automotive plant capacity to near maximum utilization in the North American market, which in turn drove demand for maintenance and re- placement equipment. However, the demand for new automation remains relatively sluggish. A key indicator for this sector is the demand for metal working machine tools and robotics automation equipment purchased by tier one and tier two component suppliers. These two sectors are in a cycli- cal downturn that began at the end of 2000. Machine tool shipments have fallen by at least 35 percent compared to 2000. Margins at all tiers are being squeezed by heavy discounting in an attempt to drive demand. Automaker Chrysler, facing a $1.2 billion loss in the current quarter, is leaning on suppliers to further lower prices or “risk losing future business”. The com- pany recently sent letter to suppliers showing the “severe gap” between their pricing and the lowest price available in the world, including price comparisons with suppliers from Europe and low-wage na- tions in Asia, such as China. The resulting ripple down the supply chain is forcing suppliers to seek ways to take even more costs out of their processes by eliminating underperforming assets and scaling back large project work for factory up- grades. To achieve this, carmakers and suppliers are focusing their capital spending on ways to cut costs and improve operational efficiencies. 93 118 0 20 40 60 80 100 120 140 1997 1998 1999 2000 2001 2002 CapEx/Revenue Revenue Aerospace Industry CapEx/Revenue vs. Revenue (1997 = 100) 87 116 0 20 40 60 80 100 120 140 1997 1998 1999 2000 2001 2002 CapEx/Revenue Revenue Automotive Industry CapEx/Revenue vs. Revenue (1997 = 100)
  12. 12. ARC Strategies • June 2003 12 • Copyright © ARC Advisory Group • ARCweb.com In Europe, premium brands like BMW and Porsche are continuing to set record sales despite recent sales drops in the key US market. However, the 25 percent drop in the value of the dollar versus the euro since last year is hurting profits for some. Interestingly, BMW, which produces automobiles in the US market, claims the company is hedged against the weaker dollar through 2004, while Volkswagen, which makes cars in Mexico for the North American market, is already feeling the pain of both slower sales and lower dollar profits. Volkswagen recently sought to gain the support of factory workers for its ongoing cost-cutting measures, citing the need for substan- tial cost savings for the company to maintain its “maneuvering room”. Italian automaker Fiat recently disappointed analysts with a softening of its turnaround plan aimed rescuing the troubled industrial giant without clos- ing plants or cutting jobs. According to ARC’s CapEx index, capital spending in the automobile in- dustry has remained steady at 5 to 6 percent of revenue since 1997. However, eroding profits have cut the industry’s ROA in half to between 2 and 3 percent during the same period. Chemicals After a disappointing year in 2002, the worldwide chemical industry is still plagued by overcapacity, weak demand, and declining prices, although some relief is in sight. Specialization, globalization, consolidation, and out- sourcing continue to be the key trends. Some chemical firms are divesting low-margin commodity bulk chemical businesses to concentrate on higher- margin specialty chemical businesses, which typically require a greater de- gree of manufacturing sophistication. Outsourcing enables companies to cut costs and eliminate production planning in their own facilities, to focus more energy and resources on product innovation and marketing. Manufacturing chemicals and allied prod- ucts is capital intensive. The real value of fine chemicals is often a function of the production technologies. In place of the high volume advantages of commodities and the performance benefits of special- ties, the value-add comes in the process 89 104 0 20 40 60 80 100 120 140 1997 1998 1999 2000 2001 2002 CapEx/Revenue Revenue Chemicals Industry CapEx/Revenue vs. Revenue (1997 = 100)
  13. 13. ARC Strategies • June 2003 Copyright © ARC Advisory Group • ARCweb.com • 13 stage. Consequently, the design of efficient, flexible and agile plants that satisfy quality requirements while complying with safety, health, and envi- ronmental legislation can mean the difference between success and failure. According to ARC’s CapEx index, capital spending as a percentage of reve- nue in the chemical industry has dropped by -2.2 percent annually since 1997. Revenue during that same time has remained mostly flat while pre- tax profits have fallen by more than half. ROA, which has suffered slightly until 2001, shrank again in 2002 to a third of 1997 levels due to poor profit performance. Food & Beverage Investments in the food & beverage industries remain focused on issues such as developing and introducing new products, maintaining and im- proving quality, ensuring safety, reducing inventories, optimizing asset utilization, and cutting costs out of supply chains. These issues continue to strongly influence capital project and operational decisions. Food & bever- age is a high volume, low margin industry, so manufacturers must hold onto their bottom lines by continuously lowering costs in production, sourcing and distribution. A high level of integration between manu- facturing and business solutions from ERP through CPM, asset man- agement, data warehouses and supply chain optimization is neces- sary to keep up with the changing landscape. The wave of acquisitions in food & beverage is causing producers to divert capital budgets to the tasks of integrating and unifying the result- ing patchwork of dissimilar plants, business systems and control archi- tectures. However, while acquisitions may divert capital spending, the sav- ings from eliminating duplicate functions appear to far outweigh the costs of integration. Unilever claims to have reached its savings target of €800 million as a result of the successful integration of recently acquired Best- foods. 82 117 0 20 40 60 80 100 120 140 1997 1998 1999 2000 2001 2002 CapEx/Revenue Revenue Food & Beverage Industry CapEx/Revenue vs. Revenue (1997 = 100)
  14. 14. ARC Strategies • June 2003 14 • Copyright © ARC Advisory Group • ARCweb.com Food & beverage manufacturers continue to focus on their supply chains as more and more product is sold through mass merchandisers like Wal-Mart and Kroger in North America or Carrefour, Royal Ahold, Metro, and Tesco in Europe. While the old mantra “Deliver what I ordered, when I want it and invoice me correctly” still holds true, large retailers are pressuring manufacturers to improve their performance by tightening logistics metrics. According to ARC’s CapEx index, capital spending as a percentage of reve- nue in the food & beverage industries has decreased steadily at -4.0 percent annually since 1997, despite annual growth in revenue of 3.3 percent. Metals & Mining The worldwide market for steel will grow by more than 4 percent in 2003, driven largely by increased demand in China. China’s production increased last year by an impressive 20 percent to 182 million metric tons, putting it far ahead of Japan (108) and the US (92). China’s sizzling growth will also ac- count for nearly all of the capacity expansion in the steel industry in 2003, while the rest of the world focuses its spend- ing on improving and optimizing existing assets. Japan’s stalled economy will keep its steel consumption at the same level as 2002. In Europe and North America, steel con- sumption will grow at 2.5 to 3.5 percent on the back of more solid manufacturing activ- ity during the year. The turmoil of bankruptcies and acquisitions in the steel industry has been marked by a - 7.4 percent annual decrease in capital spend- ing as a percentage of revenue since 1997, according to ARC’s CapEx index. During the same period, revenues have remained flat while profits have plummeted due to capacity gluts and falling prices. Oil & Gas Fluctuating oil prices caused by geopolitical instability made for a difficult year in 2002 for oil companies. Refining in particular suffered from very low margins when crude costs rose faster than product prices during a pe- riod of depressed demand growth. 68 98 0 20 40 60 80 100 120 1997 1998 1999 2000 2001 2002 CapEx/Revenue Revenue Metals Industry CapEx/Revenue vs. Revenue (1997 = 100)
  15. 15. ARC Strategies • June 2003 Copyright © ARC Advisory Group • ARCweb.com • 15 Challenges in upstream include managing oil and natural gas fields to increase pro- duction, reduce downtime, lower operating costs and optimize reserve recovery. In downstream, refiners are focusing capital budgets on cost reduction, safety enhance- ment, reduction in capital requirements, and reductions in refining energy consump- tion. In addition, a large part of capital budgets continues to go toward meeting stringent environmental regulations. Recent mega-mergers like Chevron-Texaco and Exxon-Mobil continue to claim annual sav- ings in excess of $1 billion. According to ARC’s CapEx index, capital spending as a percentage of reve- nue has decreased by -3.4 percent since 1997 while wildly fluctuating revenue due to changing oil prices has increased at an average annual rate of about 5.4 percent. Pharmaceutical Capital spending in the pharmaceutical industry is driven primarily by new drug development, along with pressure to maintain financial performance, shorten time to market and improve quality. Drug makers are also invest- ing in the technologies and infrastructures necessary to achieve and demonstrate compliance with current and future regulatory requirements. The United States is the world’s largest market for prescription drugs, and the Food and Drug Ad- ministration (FDA) has traditionally led the pack with its strict policing of the industry and the move to elec- tronic records and signatures. However, compliance with federal regulations will become even costlier with the introduction of new Euro- pean Union legislation, including the new Product General Safety (Liabil- ity) Directive 2001/95/EU, Annex 11 84 130 0 20 40 60 80 100 120 140 1997 1998 1999 2000 2001 2002 CapEx/Revenue Revenue Oil & Gas Industry CapEx/Revenue vs. Revenue (1997 = 100) 99 153 0 20 40 60 80 100 120 140 160 180 1997 1998 1999 2000 2001 2002 CapEx/Revenue Revenue Pharmaceutical Industry CapEx/Revenue vs. Revenue (1997 = 100)
  16. 16. ARC Strategies • June 2003 16 • Copyright © ARC Advisory Group • ARCweb.com of the EU Good Manufacturing Practice, Data Protection Directive 95/46/EC, and the Electronic Signature Directive 1999/93/EC. The pharmaceutical industry is still a low volume, high margin business, but this is gradually changing as the industry begins to face pressures for which drug makers are ill-prepared. These pressures are driven by weak development pipelines, crowding of therapeutic categories, new generic competition, new FDA responses, increasing socio-political price and deliv- ery pressure, and new drug delivery systems requirements. The current strategy of mergers and acquisitions to achieve financial performance and satisfy shareholders is not sustainable in the face of the global demand for affordable and available drugs, increasing demand for more new life saving drugs, and the trend toward greater global social responsibility and har- monization. The most consistently profitable drug companies will be those that succeed in shortening development times and terminating unpromis- ing drugs earlier in the development cycle. Capital spending in ARC’s CapEx index for the pharmaceutical industry increased steadily at 8.6 percent annually since 1997, in line with annual revenue growth of 8.9 percent. However, some of this is due to acquired growth from mergers. As a percentage of revenue, capital spending rose during the boom years of 1999 and 2000, only to fall back to 1997 levels last year. Pharmaceutical manufacturers have enjoyed healthy ROAs in the range of 18 to 20 percent during this period. Pulp & Paper The pulp & paper industry continues to suffer from overproduction and falling prices. Recent mergers led to more ROA- focused manufacturing as large producers attempt to become global producers by concentrating their assets on manufactur- ing paper in line with market demand rather than the previous tendency to overproduce. Increasing size has been accompanied by the introduction of more sophisticated production methods as manufacturers try to cut variable costs in the face of cheap Pulp & Paper Industry CapEx/Revenue vs. Revenue (1997 = 100) 64 144 0 20 40 60 80 100 120 140 160 1997 1998 1999 2000 2001 2002 CapEx/Revenue Revenue
  17. 17. ARC Strategies • June 2003 Copyright © ARC Advisory Group • ARCweb.com • 17 imports from Asia. Rather than build new paper mills, which can cost as much as $1 billion and take several years to build, manufacturers are con- centrating capital spending on improving existing facilities through better asset management and quicker response to changes in product demand. According to ARC’s CapEx index, capital spending as a percentage of reve- nue decreased steadily by an annual rate of -8.7 percent since 1997. Overcapacity and falling prices have caused margins to drop substantially, with many manufacturers losing money in 2002. Semiconductor Last year marked another bad year for chipmakers as revenues dropped by 4.4 percent in ARC’s CapEx index. Capital spending in the semiconductor industry has mirrored the overall downturn in the telecommunications and personal computer industries. Many manufacturers have taken advantage of the downturn to make strategic acquisitions as entrepreneurial firms with key technologies can be had for a low price. Unlike other industries, chipmakers are con- stantly faced with the challenge of inventing new manufacturing processes to produce smaller and denser chips. This is why “new” technologies like Collaborative Production Management, now being introduced in other industries, were pioneered years ago by the leading-edge semiconductor industry. Capital spending focuses for semiconductor manufac- turers continue to emphasize reducing manu- facturing costs and increasing lot yield in the face of falling prices and fluctuating demand. According to ARC’s CapEx index, capital spending in the semiconductor industries has been erratic over the past six years, returning to 1997 levels last year. Growth in spending as a percentage of revenue has mostly re- mained in line with revenue growth during the same period. Utilities The turmoil of 2002 in the energy markets has forever changed the utilities landscape, but real benefits for consumers and shareholders still vary 136 101100 95 0 20 40 60 80 100 120 140 160 1997 1998 1999 2000 2001 2002 CapEx Revenue Semiconductor Industry CapEx/Revenue vs. Revenue (1997 = 100)
  18. 18. ARC Strategies • June 2003 18 • Copyright © ARC Advisory Group • ARCweb.com widely. Newly privatized energy companies are focusing on increasing profits to keep shareholders happy, while coming to terms with the chal- lenges of profitably re-integrating energy supply chains broken up by deregulation. In addition to process improvement, capital budgets are focused on cost cutting measures through better asset management as well as improving customer respon- siveness. According to ARC’s CapEx index, capital spending as percentage of revenue for utilities has mostly kept pace with revenue growth since 1997. Recommendations • Geopolitical uncertainty, fluctuating oil prices and sluggish demand continue to hinder capital investment in most industries. As capital budgets are cut, manufacturers should focus investments on projects with a clear and measurable return, such as initiatives that cut costs, improve productivity and quality, and increase utilization of existing assets. By leaning out manufacturing processes now, companies can better position themselves to meet increasing demand when the econ- omy recovers. • Reduced capital spending spells tough times for solution providers - especially IT suppliers. Suppliers should shift their focus from pure technology to helping customers understand how the solution can con- tribute to improving their bottom line. • Manufacturers need to understand how CMM, OpX and RPM can help them improve their business by leaning out manufacturing processes, better utilizing existing assets, and shortening return time on capital in- vestments. 102 101 0 20 40 60 80 100 120 140 1997 1998 1999 2000 2001 2002 CapEx/Revenue Revenue Utilities Industry CapEx/Revenue vs. Revenue (1997 = 100)
  19. 19. ARC Strategies • June 2003 Copyright © ARC Advisory Group • ARCweb.com • 19 Analyst: David W. Humphrey Editors: Dick Hill, Chantal Polsonetti Distribution: All MAS Clients Acronym Reference: For a complete list of industry acronyms, refer to our web page at www.arcweb.com/Community/terms/terms.htm ANSI American National Standards Institute API Application Program Interface CAGR Compound Annual Growth Rate CapExCapital Expenditure CDAS Collaborative Discrete Automation System CMM Collaborative Manufacturing Management CNC Computer Numeric Control CPAS Collaborative Process Automation System CPG Consumer Packaged Goods CPM Collaborative Production Management CRM Customer Relationship Management EAI Enterprise Application Integration EAM Enterprise Asset Management ERP Enterprise Resource Planning EU European Union FDA Food & Drug Administration GDP Gross Domestic Product IT Information Technology KPI Key Performance Indicator MRP Materials Resource Planning OpX Operational Excellence OLE Object Linking & Embedding OPC OLE for Process Control PAS Process Automation System PLC Programmable Logic Controller PLM Product Lifecycle Management ROA Return on Assets ROI Return on Investment RPM Real-time Performance Management SCE Supply Chain Execution WMS Warehouse Management System Founded in 1986, ARC Advisory Group has grown to become the Thought Leader in Manufacturing and Supply Chain solutions. For even your most complex business issues, our analysts have the expert industry knowledge and firsthand experience to help you find the best answer. We focus on simple, yet critical goals: improving your return on assets, operational performance, total cost of ownership, project time-to-benefit, and shareholder value. ARC Strategies is published monthly by ARC. All information in this report is proprietary to and copyrighted by ARC. No part of it may be reproduced with- out prior permission from ARC. You can take advantage of ARC's extensive ongoing research plus experience of our staff members through our Advisory Services. ARC’s Advisory Services are specifically designed for executives responsible for developing strategies and directions for their organizations. For subscription information, please call, fax, or write to: ARC Advisory Group, Three Allied Drive, Dedham, MA 02026 USA Tel: 781-471-1000, Fax: 781-471-1100, Email: info@ARCweb.com Visit our web page at ARCweb.com
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