Asia Competition Barometer: Precision engineering

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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......

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 PE sector.
The Barometer has two dimensions: profitability and market concentration. To assess the aggregate profitability of the PE sector in Asia, the EIU developed a composite index of five ratios that each represents a different aspect of a company’s profitability. To assess market concentration, the EIU 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.

Other reports in this series look at the information technology services, pharmaceutical, transport and logistics, and petrochemicals and chemicals sectors in Asia.


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  • 1. Asia Competition BarometerPrecision engineeringAn Economist Intelligence Unit reportSupported by
  • 2. Asia Competition Barometer: Precision engineering Contents Preface 2 Executive summary 3 Asia’s growing importance for corporate performance and global competitiveness 5 Competition and profitability at Asian firms 7 Competition: Marginal increase 7 Profitability: A return to the peak 9 Case study: World Precision Machinery 11 Positioning for success in Asia 12 Sustained growth in Asia 12 Semiconductors and solar: Asian growth stories 13 Case study: Applied Materials 15 Outlook 16 Barometer methodology 18 © The Economist Intelligence Unit Limited 2012 1EDB_Engineering_main.indd 1 3/6/2012 8:40:30 AM
  • 3. 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 2 © The Economist Intelligence Unit Limited 2012EDB_Engineering_main.indd 2 3/6/2012 8:40:31 AM
  • 4. 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 3EDB_Engineering_main.indd 3 3/6/2012 8:40:31 AM
  • 5. 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 reachf 296 37.4% by 2009. Of the five sectors that the Economist Intelligence Unit analysed for this Barometer, PEces 004 is the only one where profitability continued to grow uninterrupted through the last global economic re slowdown, partly due to strong regional demand. Combined operating revenues increased from US$26.6bnedl in 2007 to US$35.1bn in 2009. • 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. 4 © The Economist Intelligence Unit Limited 2012 EDB_Engineering_main.indd 4 3/6/2012 8:40:31 AM
  • 6. 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%. 1 Asia here includes Bangladesh, China, Hong Kong, Indonesia, India, There are several broad trends that have been driving Asia’s precision engineering (PE) sector.2 The Japan, South Korea, Malaysia, Myanmar, Philippines, first is Asia’s emergence as a global manufacturing powerhouse. Over the past decade, Asia’s share of Pakistan, Singapore, Sri Lanka, Thailand, Taiwan, and global manufacturing output has increased dramatically, led by China (see Figure 1). This has boosted Vietnam demand for PE products that are used to manufacture a variety of goods. 2 The precision engineering The second trend, which is helping to underpin the first, relates to rising private consumption in Asia, sector includes the following sub-segments: instruments which is boosting regional demand for manufactured goods. Due to Asia’s rapid economic growth over the and appliances for measuring, last few years, the region is now home to a huge and growing middle class. The Asian Development Bank testing and navigation, irradiation, electromedical (ADB) estimates that between 1990 and 2008 developing Asia’s middle class population more than tripled and electrotherapeutic equipment, optical from 565m to 1.9bn. As a share of the total population, the middle class grew from 21% to 56% over that instruments and photographic period.3 equipment, power-driven hand tools, metal-forming machinery, other machine Figure 1: Share of world manufacturing output tools, other special-purpose (%, constant 2000 US$) 2000 2009 machinery, air and spacecraft 15 and related machinery and medical and dental equipment 12 and supplies. 3 “The rise of Asia’s middle 9 class”. Asian Development Bank. 2010 6 3 0 China ASEAN South Korea Taiwan India Source: UNIDO © The Economist Intelligence Unit Limited 2012 5EDB_Engineering_main.indd 5 3/6/2012 8:40:31 AM
  • 7. Asia Competition Barometer: Precision engineering Figure 2: Asia and Australasia consumption Cars (per 1,000) Mobiles subs (per 100) PCs (per 100) 120 100 80 60 40 20 0 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Source: Economist Intelligence Unit 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 4 Earth Policy Institute, 2001. for some 70% of the 24,000 MW global production that year. 4 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. 6 © The Economist Intelligence Unit Limited 2012EDB_Engineering_main.indd 6 3/6/2012 8:40:31 AM
  • 8. 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 0 (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 5 A measure of the size of in 2006 (see Figure 3), signifying that the 50 biggest firms in the Barometer saw a marginal decrease in companies in relation to the concentration between 2004 and 2009.4 industry, and an indicator of the amount of competition Competition in the PE industry grew significantly between the years 2004 and 2006. The HHI dropped among them, the HHI is from 10.39 to 5.87 over that period, signifying that the market share of the 50 biggest firms declined defined as the sum of the squares of the market shares substantially. This is largely because of an influx of new players—in those two years, 40 new Asian of the 50 largest firms from the universe of over 200 listed companies entered the industry, capturing much of the rapidly growing market. companies assessed. For more However, between 2006 and 2009, the largest firms in the industry began to steadily increase their information on the Barometer methodology, please refer to concentration once again. The HHI rose from 5.87 to 9.30 over that period. There are two reasons for this. the last section in this report. © The Economist Intelligence Unit Limited 2012 7EDB_Engineering_main.indd 7 3/6/2012 8:40:31 AM
  • 9. Asia Competition Barometer: Precision engineering Figure 3: Herfindahl–Hirschman Index 12 10 8 6 4 2004 2005 2006 2007 2008 2009 Source: Economist Intelligence Unit 2004 2005 2006 2007 2008 2009 Herfindahl—Hirschman Index (HHI) 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. Non- Asian 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 China N.A. 3.80 Xian Aircraft International China 0.15 1.24 Taiyuan Heavy Industry China 0.28 1.21 China Erzhong Group (Deyang) China N.A. 1.13 Heavy Industries 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 8 © The Economist Intelligence Unit Limited 2012EDB_Engineering_main.indd 8 3/6/2012 8:40:32 AM
  • 10. 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 6 The composite Profitability Index is made up of five in gross margin in the years 2005 and 2006 can be attributed to an increase in competition and higher ratios that each represents material costs. First, the increase in competition in 2005 and 2006 (see Figure 3) could have had a a different aspect of a company’s profitability. For negative impact on gross margins. Second, in 2005 material costs more than doubled to US$3.5bn from more information on the Barometer methodology, US$1.6bn in 2004. Over that same year, combined operating revenues increased only 25% to US$12.3bn. please refer to the last section This hurt gross margins in 2005. in this report. 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 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 Profitability index 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 Return on equity (%) 7.5 11.9 14.3 13.6 13.8 13.2 Return on assets (%) 2.7 4.4 5.1 5.5 5.3 5.3 Herfindahl—Hirschman Index (HHI) 10.39 8.63 5.87 7.73 8.44 9.30 © The Economist Intelligence Unit Limited 2012 9EDB_Engineering_main.indd 9 3/6/2012 8:40:32 AM
  • 11. 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 © The Economist Intelligence Unit Limited 2012EDB_Engineering_main.indd 10 3/6/2012 8:40:32 AM
  • 12. Asia Competition Barometer: Precision engineering Case Study: World Precision Machinery 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 World Precision Machinery: Moving up the technology ladder either independently or through joint ventures. For instance, global World Precision Machinery (WPM), an integrated manufacturer of players such as KLA-Tencor and Applied Materials have invested in precision metal stamping machines based in Jiangsu, China, has seen manufacturing plants and research and support centres in destinations its revenues multiply five-fold between 2005 and 2010. In the first nine such as China, India, Malaysia, Singapore and Taiwan. months of 2011, the firm had revenues of RMB 947.9m (US$150.1m), Mr Shao expects stiff competition in the PE sector over the next few amounting to year-on-year growth of 30%. years. He says that Asian firms have started to move up the technology Shao Jian Jun, the company’s executive director and CEO, says ladder, while non-Asian firms that have an Asian presence have started WPM derives more than 95% of its sales from China currently and lowering production costs. that Asia’s standing as the world’s manufacturing hub will continue In the face of this rising competition, a key part of WPM’s strategy to present business opportunities for the company as “the stamping is vertical integration: the company has the capability to design 90% industry forms the backbone of many manufacturing industries”. of the equipment it produces. According to Mr Shao, over the next five WPM is currently one of the three largest manufacturers of metal years, profitability in the PE industry will be driven by market demand stamping machines in China. It mostly supplies manufacturers in home on the one hand, and cost control, production efficiency and price appliances (34% of revenues), automobiles (32%) and electronics competitiveness on the other. Technology innovation will also be (15%), while it earns the rest of its revenue from several other sectors. important, he says. This is reflected in WPM’s decision to employ more Mr Shao attributes the profitability in the industry to “a boom than 200 R&D and technical staff in two Chinese cities, Danyang and in market demand, [the rising value of] brand names, price Shanghai. competitiveness and technology innovation”. However, he adds © The Economist Intelligence Unit Limited 2012 11EDB_Engineering_main.indd 11 3/6/2012 8:40:32 AM
  • 13. 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.) China Euro Area (AGG) India Indonesia Singapore US 10 8 6 4 2 0 -2 2010 2011 2012 2013 2014 2015 2016 Source: Economist Intelligence Unit 12 © The Economist Intelligence Unit Limited 2012EDB_Engineering_main.indd 12 3/6/2012 8:40:32 AM
  • 14. 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 7 Global Sales Report. Semiconductor Industry In 2010, the global semiconductor market grew by US$72bn or 31.8%, with Asia accounting for Association. Various years 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 West Europe World (see Figure 7). 150 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 manufacturers. Asia has become the most 30 important market for companies in this space. 0 Mobile subs (per 100) PCs (per 100) Additionally, semiconductor manufacturers Source: Economist Intelligence Unit relentlessly invest in new technology in order 8 Moore’s law is named after to lower the unit costs of processing power. “Consumer end-demand for electronics, most recently in Gordon Moore, co-founder smartphones and tablet computers, has historically driven competition in our industry to make faster, of Intel, a computer chip manufacturer, who predicted more complex, and cheaper semiconductors in line with Moore’s law,” says Mr Tham at Applied Materials.8 that computer processing power—measured by the He cites the iPod as an example. An iPod built in the 1970s at the cost-per-transistor then would have cost number of transistors on an US$3.2bn and would have been the size of a house; however, with innovation in line with Moore’s law, integrated circuit—would rise exponentially, doubling every today an iPod costs US$250 and fits into a pocket. 18 months or so. © The Economist Intelligence Unit Limited 2012 13EDB_Engineering_main.indd 13 3/6/2012 8:40:32 AM
  • 15. 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 © The Economist Intelligence Unit Limited 2012EDB_Engineering_main.indd 14 3/6/2012 8:40:33 AM
  • 16. Asia Competition Barometer: Precision engineering Case Study: Applied Materials He believes the PE sector itself is increasingly capital intensive, particularly with the development of technologies such as three- dimensional integrated circuits, which require “significant RD&E Applied Materials: Continued growth in Asia [research, development and engineering] resources and investment Applied Materials, with revenues of more than US$10bn in 2011, is that are only available to global players.” Mr Tham suggests that the world’s largest supplier of manufacturing equipment and services competition-driven consolidation among the PE industry’s customers for the semiconductor, flat-panel display and solar industries. “About could lead to a similar consolidation in the PE industry itself. In 75% of our revenue comes from Asia, up from about 50% a decade May 2011, Applied Materials acquired Varian Semiconductor for ago. We have a significant presence throughout Asia in China, Taiwan, US$4.9bn and in November 2009, it paid approximately US$364m Singapore, India, Japan and South Korea, and are continuing to grow to buy Semitool, another semiconductor company. Similarly, wafer our footprint in the region,” says Russell Tham, regional president of fabrication equipment supplier Lam Research agreed to buy rival Applied Materials South East Asia. Novellus Systems for US$3.3bn in December 2011. Since establishing itself in Asia more than 20 years ago with sales To gain a competitive advantage, says Mr Tham, PE companies will and technical support functions, Mr Tham says that the company has have to invest in R&D “to address an increasing number of technology added “strategic and operational roles to cater to a market base that is inflection points in order to enable Moore’s law and produce newer shifting to Asia, and to improve cost competitiveness.” technologies at ever cheaper costs.” He adds that these innovations “Competition to keep up with Moore’s Law, which drives increasingly will involve new materials, unique integrated circuit design advanced semiconductors, has resulted in a trend of consolidation architectures, novel patterning structures and larger substrates. “The for our semiconductor manufacturing customers, as well as ever trend of globalisation has also seen companies optimise their global increasing capital investment required to achieve the profitable footprint through the development of lower cost operations and supply economies of scale,” Mr Tham says, in explaining the high investment chains, especially in Asia,” he adds. barriers involved in the semiconductor industry. © The Economist Intelligence Unit Limited 2012 15EDB_Engineering_main.indd 15 3/6/2012 8:40:33 AM
  • 17. 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 © The Economist Intelligence Unit Limited 2012EDB_Engineering_main.indd 16 3/6/2012 8:40:33 AM
  • 18. 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 17EDB_Engineering_main.indd 17 3/6/2012 8:40:33 AM
  • 19. 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 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. 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 do 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 © The Economist Intelligence Unit Limited 2012EDB_Engineering_main.indd 18 3/6/2012 8:40:33 AM
  • 20. 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 9 Or summed for all the firms of the squares of the market shares of the 50 largest firms from the universe of over 200 listed companies in the case that there are assessed.9 HHI values can range from 0 to 1.0, moving from an extremely fragmented market (0) to a fewer than 50. © The Economist Intelligence Unit Limited 2012 19EDB_Engineering_main.indd 19 3/6/2012 8:40:33 AM
  • 21. 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 © The Economist Intelligence Unit Limited 2012EDB_Engineering_main.indd 20 3/6/2012 8:40:33 AM
  • 22. Whilst every effort has been taken to verify the accuracyof this information, neither The Economist IntelligenceUnit Ltd. nor the sponsor of this report can accept anyresponsibility or liability for reliance by any person on thisreport or any of the information, opinions or conclusionsset out herein.