Roland BeRgeR StrateGy ConSultantS

Fresh thinking for decision makers

Content

maRch 2012

German mechanical engineering and its path toward the new "middle"| Pressure from two directions|Capacities are shifting to the newly industrialized countries| Customers more concerned about price

Quality alone will no longeR Be enough

geRmany is incReasingly having to deFend its maRket leadeRship against china. "made in geRmany" may no longeR solely mean expensive high-tech. the path towaRd a gloBal "mid-end" has Been launched now it must Be RigoRously expanded and solidiFied.

MADE IN GERMANY

MADE IN CHINA

CHINA wIll fuRtHER

INCREAsE Its sHARE of GlobAl

MACHINERY pRoDuCtIoN

Germany's share of global machinery production:

China's share of global machinery production:

in 2010

in 2015

in 2010

in 2015

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production systems 2020

the new middle

the world market for mechanical engineering is changing radically. Demand for production systems and machinery increasingly comes from emerging markets. What's more, manufacturing capacities itself will steadily shift over the next decade from the industrialized West to asia. this obviously has serious consequences for German exporters, who so far have been rightly proud of their record as highly successful technology leaders in these target markets. But to stay ahead, "Made in Germany" must stand for more than highly productive, expensive high-tech. the new customers in the emerging markets are keeping a careful eye on price. rising demand for high-value consumer goods in emerging economies impacts on local manufacturing structures. the new machines now being installed are increasingly sophisticated, and existing ones are being upgraded in terms of both quality and performance specifications. this is an expansion of the middle, or "Mid-end" a segment where Western companies face growing local competition. a struggle has broken out between Chinese and europeans for the new "middle". leading German engineering firms have already put their strategic focus on emerging markets and Mid-end technologies. this successful model must be further expanded in the industry on the european level. our latest study on "Production Systems 2020" shows that the europeans are well prepared thanks to their outstanding industrial expertise. they enter the race from a strong position because, globally, the engineering sector has resumed its upward trend. Medium-term growth for the world market is expected to be nearly 8% a year through to 2015, equaling pre-crisis levels. So those manufactures who focus on customers and their new needs can enjoy good prospects. By aligning their product portfolio and management to an expanding market, successful engineering companies should continue to do well on the world market. But there is one important proviso here: Global success can no longer be achieved only by exporting from europe. So what exactly are the strategies that will produce future winners? We first have to distinguish between global volume producers and the niche suppliers.

2012:
gloBal demand FoR stationaRy machines and pRoduction systems in euRo.

shiFt in pRoduction and demand to asia will acceleRate

In terms of production volume, Germany was the world's number one on the production engineering market from 2003 to 2007. Since then, Germany and Japan, once the largest producer in asia, have seen their dominance in volume wane, although they have maintained their technological edge. In 2010, China became the biggest manufacturer of machines worldwide. Despite various contradictory economic signals, we expect to see growth in China averaging well above 10% through 2015. this is well above the asian average and far higher than the annual average for the mechanical engineering industry worldwide. Growth in europe will lag significantly, hovering around an annual average of 5.7%. Germany will at least stay ahead in europe thanks to the industry's very high export share (75%). Japan is now only number four on the world market. as for north and South america, producers will see annual growth of over 5%.

Roland BeRgeR StrateGy ConSultantS

Going forward, Germany can expect to lose its number-one spots in four different segments to China. By 2015, China will clearly be the largest producer in machine tools and plastics machinery. In the long run, Germany is likely to maintain global leadership only in those areas of technology for which high application expertise and process know-how are critical.

thRee options:

in the medium teRm, the "mid-end-maRket" segment will expand Fastest

Growth of the "Mid-end" market will be forced by displacing the "low-end" in asia and at the expense of the "High-end" in europe. the rise of the middle classes in emerging economies is pushing up the quality and reliability expected of consumer goods and equipment. this, in turn, means that production processes in asia will improve. Greater reliability, productivity and precision will be required. the specifications for production systems and machines are becoming more demanding. and this trend is reinforced by Chinese manufacturers seeking to export a growing share of their own output to developed markets. at the same time, consumer goods producers in europe face growing cost pressures. So they take an increasingly critical view of any "High-tech" frills that do not discernibly add productivity, reliability or service-friendliness to their product. the technological requirements of machines are therefore moving toward the "Mid-end" from two directions. "Mid-end" products must be available 24/7 as well as feature high performance, precision and reliability. at the same time, customers will settle for less automation, fewer extras and limited customization. they are also willing to accept less flexibility in return for higher specifications in standard models. this, then, is the technological middle the "Mid-end". It is already the highest volume segment in global production engineering. and, going forward, the "Mid-end" will continue to expand faster than other segments and dominate the industry.

conQueRoR

FolloweR

a Question oF alignment diFFeRent stRategies FoR diFFeRent tempeRaments

In response to these market trends, the european companies have adopted various strategies. We can divide machine manufacturers in the established markets into three typical groups: the conquerors actively pursue globalization and are prepared to take high commercial risks. they keep trying to develop new business segments and want to make their mark in China with a broad presence whether through mergers, joint ventures or organic growth. the followers Prefer taking only moderate risks even if this means accepting only limited growth. their expansion strategy centers on organic growth. to secure long-term success in emerging markets, they will at least set up marketing and service structures.

oR oBseRveR

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production systems 2020

the observers Pursue conservative strategies and shun risk-taking. their success is based on exporting from europe and leveraging (wage) cost advantages from low-cost countries. they watch the market carefully and act only when they spot a safe opportunity. It is above all companies in the "conquerors" group that actively seize the initiative when it comes to market positioning, product development and setup of global organizations. their competitive strategies tend to differ depending on whether they operate as volume producers or niche suppliers.

volume pRoduceRs Between spRing-cleaning and Realignment

the volume producers, in particular, have to rigorously continue developing the relevant models for success as they get ready to face the medium- and long-term challenges. 1. spring-cleaning the product portfolio: Aligning products to the "Mid-End" segment the product range must be revamped for the "mid-end" segment. it will not be sufficient to expand down "from above" into this segment, because this approach makes the product portfolio far more complex for an individual machine maker. Rather, these firms must simultaneously reengineer their portfolios and reduce them to a manageable size. what's more, the design of new machines must again be streamlined to ensure that their functionalities are closely aligned to the needs of the market (cost discipline!). When widening their portfolio, european machine building companies will apply different branding strategies depending on the strengths of their direct competitors from China. For instance, producers like Krones have used a separate brand (here: "Kosme") for the "Mid-end" segment and, technologically, position the brand very close to the "High-end" range. on the other hand, companies such as Sumitomo Demag choose not to differentiate their "Mid-end" from their "High-end" machines in their branding policy. Producers with a clear technology and performance gap between the "High-end" and "Mid-end" range adopt a twin-brand strategy. one reason for this is that, unlike their "Mid-end" products, the "High-end" machines contain a large proportion of customized solutions. those engineering companies whose product portfolio has been shifting steadily from "High-end" to "Mid-end" have generally opted for a one-brand strategy. For these firms, the distance between the two segments is not particularly great. their product structure often allows them to move their "Mid-end" machines closer to the "High-end" products either by modular expansion or transport systems and automation combining stand-alone machines.

the intelligent alteRnative: a "tHIRD wAY" Between "Bottom up" and "top down"

Roland BeRgeR StrateGy ConSultantS

2. product development is getting smarter: the "third way" between "bottom up" and "top down" opinions differ widely on the question as to whether new machines should be designed "bottom up" (from the product perspective) or "top down" (from the market perspective). this is because the approaches are very different. a machine that meets the needs of the market has to provide certain functions at a certain price. so the aim of product development is clearly defined from the outset. a very different situation arises when the development team puts together new elements with tried and tested components in order to create a novel and attractive product. Both approaches have strengths and weaknesses. so we recommend an intelligent combination a "third way" aimed at functional units and not at technical modules. producers who take this "third way" when developing "mid-end" products must first divide the whole machine into functional packages. For every functional unit, a decision must be made on whether the technology and components - can be adopted without changes from the "high-end" version ("as is") - the "high-end" version should serve merely as the basis for a reduced and cheaper solution ("cost out") - should be developed from scratch in line with low-cost principles ("bottom up")

subsIDIARIEs must
Be Fully Functional to achieve an autonomous position on the local maRket.

the overriding goal of the "third way" is to reduce the manufacturing costs of machines. only by creating adequate transparency on costs can managers work out the financial consequences that flow from each decision on the technical options. 3. Globalization strategy must be multilayered: thinking through organization, assets, R&D and investment today's maxim for companies: the headquarters lays down the strategic framework for the group, but implementation is decentralized. in a globalized strategy, the details are best left to the companies on the ground and national subsidiaries. when it comes to globalizing research and development, a range of solutions are employed in practice. they differ in the extent to which value is added locally and in the role played by local units. we find that some centralized control over R&d is indispensable for market success. But at the same time, there must also be enough room for local R&d units to contribute their regional know-how on the market and pool their own development philosophy into the group's R&d strategy. in particular, where a new product is conceived for a specific region, it is vital to have technical design input from that region.

niche supplieRs can deFend theiR know-how lead

the "High-end" market will remain particularly attractive for German engineering even over the long term. the high level of technology and process expertise required here presents a major barrier to entry by competitors from emerging economies.

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production systems 2020

the niche suppliers will not have to radically overhaul their products or their strategy. In their market, they can continue to compete on the basis of their products and not on cost. 1. Even niche producers should streamline their product portfolio: by setting strategic priorities in the project pipeline. not everything that is technically possible makes commercial sense. new projects must offer an attractive relationship between net present value and R&d investment. in light of the diverse technological possibilities, it is worth pointing out something that may seem obvious: manufacturers should focus their efforts above all on development projects that promise the best cost-benefit ratio. any technology projects without a robust business model must be critically challenged. 2. Approved R&D toolkits make R&D management more effective and more productive. the traditional r&D management solution offers companies a number of standard procedures and management and control methods, including project monitoring and reporting, performance benchmarking or modularization. From these tools, each manufacturer must put together the best possible package for their situation. 3. be selective when relocating parts of the value chain to low-wage countries. It is only in rare cases that niche suppliers can achieve cost advantages by relocating plants abroad. Quality requirements are often too high for such a move. the exacting specifications demand close coordination of all production processes. another factor is financial burden and management strain. niche suppliers may lack the resources needed for a comprehensive expansion of their global presence. they should therefore adopt a highly selective approach, integrating into their value chain only those production steps from low-wage countries that really fit. the foreign bases will serve as an "extended workbench", but they must be properly integrated in the group structure.

the FoRmula FoR success: FRom "HIGH-END" to

"MID-END"

iF you have any FuRtheR Questions, please contact us: Dr. Martin Eisenhut, Senior Partner +49 (89) 9230-8262 martin_eisenhut@[Link] Dr. Ralph Lssig, Partner +49 (89) 9230-8541 ralph_laessig@[Link] Jrgen Liedl, Senior Project Manager +49 (30) 39927-7134 juergen_liedl@[Link]

conclusion: the gloBal "mid-end"-segment pRomises long-teRm success

there is a growing demand for high-value consumer goods emerging markets. this leads engineering companies in the developed economies to shift from "High-end" to "Mid-end" products. the european and, in particular, German engineering sector will see some radical changes going forward. the real challenge is not how to ride out the next crisis but how to expand into the global "Mid-end" segment. to achieve success here, companies must continue to regularly challenge and adjust their business models and structures. our study shows that most european machine and plant makers belong to the largest category of companies we call "the followers". this can prove a successful strategy, but only if they make some smart moves.

think:act CoNtENt
Editors: Dr. Martin C. Wittig, Charles-Edouard Boue Overall responsibility: Torsten Oltmanns Projektmanagement: Dr. Katherine Nlling Gestaltung: Roland Berger Media Design
Roland Berger Strategy Consultants GmbH Am Sandtorkai 41 20457 Hamburg +49 40 37631-4421 news@rolandberger [Link]

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