asia competition barometer - precision engineering (economist intelligence unit. 2010)

Asia Competition BarometerPrecision engineeringAn Economist Intelligence Unit report

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© The Economist Intelligence Unit Limited 2012 1

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:Areturntothepeak 9

Case study: World Precision Machinery 11

Positioning for success in Asia 12 SustainedgrowthinAsia 12

Semiconductorsandsolar:Asiangrowthstories 13

Case study: Applied Materials 15

Outlook 16

Barometer methodology 18

EDB_Engineering_main.indd 1 3/6/2012 8:40:30 AM

© The Economist Intelligence Unit Limited 20122


SupportedbySingapore’sEconomicDevelopmentBoard(EDB),theEconomistIntelligenceUnithasdevelopedtheAsiaCompetitionBarometerwiththeaimofunderstandingthechangingmarketdynamicsinkeysectorsandassessingtheintensityofcompetitioninthem.Drawinguponcompany-leveldataonprofitabilityandotherindicators,theBarometerquantifiesthechangingdynamicsofcompetitivenessinAsiaforselectindustriesbetween2004and2009.

ThisreportfocusesontheBarometerfindingsfortheprecisionengineering(PE)sector.Assessingauniverseofover200PEcompaniesthatarepubliclylistedineightcountries—China,India,Indonesia,Malaysia,thePhilippines,Singapore,ThailandandVietnam—theBarometerexamineschangingprofitabilityandthecompetitionlandscapeforthesector.

Otherreportsinthisserieslookattheinformationtechnologyservices,petrochemicalsandchemicals,pharmaceuticals,andtransportandlogisticssectorsinAsia.

January2012

Preface




Executive summary

WhatdoestheemergenceofAsiaasamajorengineofglobaleconomicgrowthmeanforcompaniesoperatingintheregion?Asia’srobusteconomicoutlook—coupledwithdiminishedgrowth

prospectsinmanyotherpartsoftheworld—hasattractednewinvestmentintothemarketbothfromregionalplayersandWesternmultinationals.Asaresult,competitionintheregionisexpectedtointensify.Giventhedarkeningglobaleconomicoutlook,andtheexpectedimpactonsomeeconomiesandsectorsintheregion,growthandprofitabilitylookuncertaininthenearterm.Butoverthemediumtolongerterm,Asia’sstrongeconomicfundamentalswillensureconsistentgrowthacrossarangeofindustries.HowarecompaniespositioningthemselvestocapitaliseonAsia’sgrowthoverthenextfewyears?

TheAsiaCompetitionBarometerassessestheintensityofcompetitionandchangingmarketdynamicsinseveralkeysectors.Thisreportexaminestheprecisionengineering(PE)sector,whichincludesthefollowingsub-segments:instrumentsandappliancesformeasuring,testingandnavigation,irradiation,electromedicalandelectrotherapeuticequipment,opticalinstrumentsandphotographicequipment,power-drivenhandtools,metal-formingmachinery,othermachinetools,otherspecial-purposemachinery,airandspacecraftandrelatedmachineryandmedicalanddentalequipmentandsupplies.

Amongthekeyfindingsofthisreportarethefollowing:

• Over the past decade, Asia’s emergence as a manufacturing powerhouse has led to a boom in demand for PE products.PEcomponentsandmachineryformthebackboneofmanyindustrialprocesses,includingintheautomotive,aerospaceanddefence,consumerelectronics,solarenergyandmedicaldevicesectors.AsmanufacturingfirmsinAsiamoveupthevaluechaintoproduceevermoresophisticatedproducts,theywillfurtherboostdemandforPEproducts.

• Profitability in Asia’s PE sector has continued to grow, despite the global financial crisis.Profitabilityplummetedin2005,butsincethenhassteadilyincreased.Theaveragegrossmarginofpublicly-




1Weassessedatotalof296publicly-listedITservicesfirmsinAsiabetween2004and2009.In2009,therewere279whowerelistedandpublishedfinancialstatements.

listedAsianfirmsdeclinedfrom43.1%in2004to27.6%in2005.Thiswasduelargelytoanincreaseincompetitionandaspikeinmaterialcoststhatyear.Theaveragegrossmarginthenrosesteadilytoreach37.4%by2009.OfthefivesectorsthattheEconomistIntelligenceUnitanalysedforthisBarometer,PEistheonlyonewhereprofitabilitycontinuedtogrowuninterruptedthroughthelastglobaleconomicslowdown,partlyduetostrongregionaldemand.CombinedoperatingrevenuesincreasedfromUS$26.6bnin2007toUS$35.1bnin2009.

• 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.TheriseofAsia’smiddleclasshasbeenaccompaniedbyanincreaseindiscretionaryspending,particularlyongoodssuchascars,mobilephonesandcomputers.Thishas,inturn,drivengrowthintheregion’sPEsector.Still,itremainstobeseenifthisindigenousregionalgrowthwillbeabletooffsetthelikelyslowdownindemandintheWestoverthenextfewyears.PEfirms’successoverthenextfewyearswilldependonhowaccuratelytheyhaveplannedforandmanagedthisshift,particularlygiventhebroaderglobalmacroeconomicuncertainty.

• The PE industry is evolving rapidly, as low-cost Asian producers and high-technology Western firms seek to acquire each other’s competitive advantages.GlobalPEfirmshavebeenmovingintoAsiatotapitsburgeoningmarket,andtolowertheirproductioncostsbyshiftingcapacityfromhigher-costcountriestoAsia.Meanwhile,Asiancompanieshavebeenadaptingtothiscompetitivethreatbyplacingagreateremphasisontechnologicaladvancementinordertomoveupthevaluechainandproducemoresophisticatedmachinery.AsianPEfirmsareeagertotransformfrombeingsimplecontractmanufacturerstoprovidingproductionandsupplychainmanagementcapabilities.Thisemphasisisreflectedinafive-foldincreaseinAsianfirms’totalR&Dexpenditurebetween2004and2009.Asaresult,Asia’sPEindustryhasbeenwitnessingtheconfluenceoftwohithertodistinctbusinessmodels.

• The number and size of players in Asia’s PE sector is growing.Thenumberandsizeofpublicly-listedfirmsinthePEsectorinAsiahasincreaseddramatically.Thetotalnumberoflistedcompaniesintheindustryincreased57%between2004and2009,from131firmsto206.Overthesameperiod,thetotalcombinedrevenueofpublicly-listedPEcompaniesmorethantripledfromUS$9.8bntoUS$35.1bn;thesefirms’combinedtotalassetsrosefromUS$13bntoUS$63.3bn.

• Competition has increased only marginally, with the industry’s biggest players continuing to expand their positions.CompetitioninthePEindustrygrewsignificantlybetweentheyears2004and2006,largelyduetoaninfluxofnewplayersintothesector.However,between2006and2009,thelargestfirmsintheindustrybegantosteadilyincreasetheirconcentration,partlybyexploitingeconomiesofscale.Arelatedtrendthathasbenefittedlargefirmsisgreaterverticalintegration,asPEcompaniesseektodiversifytheirproductofferingsandprovidemorecomprehensiveend-to-endservicestotheircustomers.InthefuturethesectorislikelytobecharacterisedbyfiercecompetitionbetweenbigAsianandnon-Asianplayers,whomayincreasinglyresembleoneanother.




Asia’s growing importance for corporate performance and global competitiveness

Overthepastdecade,Asiahasrapidlygrowninimportancetotheglobaleconomy.ItsshareofglobalGDP,measuredinpurchasing-powerparityterms,increasedfrom26.8%in2001to33.8%in2010.1

By2016,theEconomistIntelligenceUnit(EIU)expectsthisproportiontoriseto38.9%.ThereareseveralbroadtrendsthathavebeendrivingAsia’sprecisionengineering(PE)sector.2 The

firstisAsia’semergenceasaglobalmanufacturingpowerhouse.Overthepastdecade,Asia’sshareofglobalmanufacturingoutputhasincreaseddramatically,ledbyChina(seeFigure1).ThishasboosteddemandforPEproductsthatareusedtomanufactureavarietyofgoods.

Thesecondtrend,whichishelpingtounderpinthefirst,relatestorisingprivateconsumptioninAsia,whichisboostingregionaldemandformanufacturedgoods.DuetoAsia’srapideconomicgrowthoverthelastfewyears,theregionisnowhometoahugeandgrowingmiddleclass.TheAsianDevelopmentBank(ADB)estimatesthatbetween1990and2008developingAsia’smiddleclasspopulationmorethantripledfrom565mto1.9bn.Asashareofthetotalpopulation,themiddleclassgrewfrom21%to56%overthatperiod.3

1AsiahereincludesBangladesh,China,HongKong,Indonesia,India,Japan,SouthKorea,Malaysia,Myanmar,Philippines,Pakistan,Singapore,SriLanka,Thailand,Taiwan,andVietnam

2 The precision engineering sectorincludesthefollowingsub-segments:instrumentsandappliancesformeasuring,testingandnavigation,irradiation,electromedicalandelectrotherapeuticequipment,opticalinstrumentsandphotographicequipment,power-drivenhandtools,metal-formingmachinery,othermachinetools,otherspecial-purposemachinery,airandspacecraftandrelatedmachineryandmedicalanddentalequipmentandsupplies.

3“TheriseofAsia’smiddleclass”.AsianDevelopmentBank.2010

Figure 1: Share of world manufacturing output(%, constant 2000 US$)

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IndiaTaiwanSouth KoreaASEANChina

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Source: UNIDO




Thesenewconsumershavebeenspendingonproductssuchascars,mobilephonesandcomputers.Between2001and2010,mobilephonepenetrationinAsiaandAustralasiarosefrom10.9%to70.6%whilepersonalcomputerpenetrationincreasedfrom4.4%to18.7%(seeFigure2).Overthatsameperiod,thestockofpassengercarsper1000peopleintheregiongrewfrom34.2unitsto54.1.Asiahassomeofthefastestgrowingautomobilemarketsaswellassomeofthelargestautomobilemanufacturersintheworld.In2009,ChinaovertooktheUnitedStatesastheworld’sbiggestcarmarket.Between2011and2015,theEIUexpectsAsiatosee157.5mmorepassengervehiclesand54.7mmorecommercialvehiclesonitsroads.

Importantly,allthreemarketscontinuedtoexpandrightthroughtheglobaleconomicdownturnin2008-09,reflectingtheresilienceofAsianprivateconsumption.TheEIUforecaststhatby2016,therewillbe84.8carsper1000people,whilemobileandcomputerpenetrationwillhavereached112%and32.5%respectively.

ThethirdtrenddrivingAsia’sPEindustryisthegrowingglobalinterestinrenewableenergy,duetoconcernsovertheenvironmentanddeclininghydrocarbonstocks.Thisisboostingdemandfor,amongotherthings,solarphotovoltaic(PV)cells,whichusesemiconductorsmadewithPEproducts.AsianmanufacturersdominatetheglobalindustryintheproductionofsolarPVcells.CombinedPVproductioninChina,TaiwanandJapanincreasedfromlessthan700MWin2004to16,800MWin2010,accountingforsome70%ofthe24,000MWglobalproductionthatyear.4RussellTham,regionalpresidentofAppliedMaterialsSouthEastAsia,saysthatalthoughAppliedMaterialsenteredthesolarbusinessonlyin2006,ithasbeenthefirm’sfastestgrowingsegment,andnowcontributesabout20%ofitsrevenues.AppliedMaterialsalsonowrunsasolarR&DcentreinXi’an,China.

Figure 2: Asia and Australasia consumption

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120PCs (per 100)Mobiles subs (per 100)Cars (per 1,000)

2016201520142013201220112010200920082007200620052004200320022001

Source: Economist Intelligence Unit

4EarthPolicyInstitute,2001.




Competition and profitability at Asian firms

Thenumberandsizeofpublicly-listedfirmsinthePEsectorinAsiahasincreaseddramatically.Thenumberoflistedcompaniesincreased57%between2004and2009,from131firmsto206.Over

thesameperiod,thetotalcombinedrevenueofpublicly-listedPEcompaniesmorethantripledfromUS$9.8bntoUS$35.1bn,whiletheircombinedtotalassetsrosefromUS$13bntoUS$63.3bn.Meanwhile,whilethereisnoauthoritativedataonforeigndirectinvestmentinthePEsector,mediareportsandindustryinterviewsindicatearapidincreaseininvestment.Theinfluxofnewplayers,bothAsianandnon-Asian,intotheregion’sPEsectorhasledtoamarginallymorecompetitiveoperatingenvironment.

Competition: Marginal increaseWithmanycompaniesraisingtheirexpectationsofAsiatodelivergrowthandprofits,itisreasonabletoexpectcompetitionintensityintheregiontoincrease.TocapturethisintensitywehaveusedtheHerfindahl–HirschmanIndex(HHI),whichmeasuresthemarketconcentrationofanindustry’slargestfirms.HHIvaluescanrangefrom0(extremelyfragmentedmarket)to1.0(monopoly).Herewehavemultipliedthevaluesby100toachieveascaleconsistentwithprofitabilityindicators(seebelow).TheHHIforAsia’sPEindustrydecreasedfrom10.39in2004to9.30in2009,afterhavinghitalowof5.87in2006(seeFigure3),signifyingthatthe50biggestfirmsintheBarometersawamarginaldecreaseinconcentrationbetween2004and2009.4

CompetitioninthePEindustrygrewsignificantlybetweentheyears2004and2006.TheHHIdroppedfrom10.39to5.87overthatperiod,signifyingthatthemarketshareofthe50biggestfirmsdeclinedsubstantially.Thisislargelybecauseofaninfluxofnewplayers—inthosetwoyears,40newAsiancompaniesenteredtheindustry,capturingmuchoftherapidlygrowingmarket.

However,between2006and2009,thelargestfirmsintheindustrybegantosteadilyincreasetheirconcentrationonceagain.TheHHIrosefrom5.87to9.30overthatperiod.Therearetworeasonsforthis.

5Ameasureofthesizeofcompanies in relation to the industry,andanindicatoroftheamountofcompetitionamongthem,theHHIisdefinedasthesumofthesquaresofthemarketsharesofthe50largestfirmsfromtheuniverseofover200listedcompaniesassessed.FormoreinformationontheBarometermethodology,pleaserefertothelastsectioninthisreport.




Figure 3: Herfindahl–Hirschman Index

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2004 2005 2006 2007 2008 2009

Herfindahl—Hirschman Index (HHI) 10.39 8.63 5.87 7.73 8.44 9.30

First,from2007to2009,onlyahandfulofnewcompaniesenteredthesector,hencetheincumbentswereabletogrowtheirmarketshare.

Second,overthepastfewyears,PEfirmshaveengagedinfiercepricecompetition,drivingdowncostsbyimprovingtheefficiencyoftheirproductionprocesses.Inthisenvironment,thelargercompanieshavebeenbetterabletoexploiteconomiesofscale,improvingtheircompetitivepositionandwinningmarketshare.Arelatedtrendthathasbenefittedlargefirmsisgreaterverticalintegration,asPEcompaniesseektodiversifytheirproductofferingsandprovidemorecomprehensiveend-to-endservicestotheircustomers.

Thefivelargestcompaniesby2009turnover—Larsen&Toubro,ChinaCSSCHoldings,Xi’anAircraftInternational,TaiyuanHeavyIndustryandChinaErzhongGroup(Deyang)HeavyIndustries—aresignificantlybiggerthantheirpeers(seeFigure4).

IndustrytrendssuggestthattherewillbeincreasedpriceandtechnologycompetitioninAsia.Non-Asianfirmshaveenteredtheregionoverthelastfewyearstolowertheirproductioncostsandbecloserto

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

ChinaCSSCHoldings China N.A. 3.80

Xi'anAircraftInternational China 0.15 1.24

TaiyuanHeavyIndustry China 0.28 1.21

ChinaErzhongGroup(Deyang)HeavyIndustries China N.A. 1.13

ShenyangMachineTool China 0.47 0.90

KNMGroup Malaysia 0.56 0.61

Hi-PInternational Singapore 0.44 0.59

DahengNewEpochTechnology China 0.43 0.49

AlstomProjectIndia India 0.19 0.46

Note:ThesearethetenbiggestcompaniesbyturnoverthatwereanalysedintheBarometer,whichconsideredonlypubliclylistedfirmsineightcountries:China,India,Indonesia,Malaysia,thePhilippines,Singapore,ThailandandVietnam




keyclients.Meanwhile,Asiancompaniesthathavehithertocompetedmainlyonpricearenowfocussedonlearningnewtechnologiestomoveupthevaluechain,saysShaoJianJun,executivedirectorandCEOofWorldPrecisionMachinery,anintegratedmanufacturerofprecisionmetalstampingmachines.Asaresult,thesetwopreviouslydistinctPEbusinessmodels—broadly,thehigh-technologyWesternmodelandthelow-costAsianone—arebeginningtomeld.

Profitability: A return to the peakTomeasuretheprofitabilityofthePEsector,wedevelopedacompositeindexoffiveratiosthatmeasuredifferentaspectsofacompany’smargins(formoredetails,seethenoteonmethodologyattheendofthisreport).AccordingtoourBarometer,withtheexceptionofgrossmargin,allotherprofitmarginshaverisenrelativeto2004(seeFigure5).

TherewasasharpfallintheProfitabilityIndexin2005,whichcanbelargelyattributedtoasharpfallingrossmarginfrom43.1%to27.6%.6Grossmarginalsodeclinedmarginallyin2006to27.2%.Thefallingrossmarginintheyears2005and2006canbeattributedtoanincreaseincompetitionandhighermaterialcosts.First,theincreaseincompetitionin2005and2006(seeFigure3)couldhavehadanegativeimpactongrossmargins.Second,in2005materialcostsmorethandoubledtoUS$3.5bnfromUS$1.6bnin2004.Overthatsameyear,combinedoperatingrevenuesincreasedonly25%toUS$12.3bn.Thishurtgrossmarginsin2005.

Sincethatyear,however,AsianPEcompanieshaveseenasteady,albeitgradual,increaseinoverallprofitabilityresultinginthesamelevelsofprofitabilityin2009asin2004.Thiscanlargelybeattributed

Figure 5: Profitability Index

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2004 2005 2006 2007 2008 2009

Profitability index 126.1 100.0 102.2 111.8 117.5 126.1

EBITDAmargin(%) 11.7 12.0 12.1 14.0 13.0 14.4

Grossmargin(%) 43.1 27.6 27.2 30.5 34.2 37.4

Returnoncapitalemployed(%) 10.2 13.3 14.8 13.5 13.4 12.6

Returnonequity(%) 7.5 11.9 14.3 13.6 13.8 13.2

Returnonassets(%) 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

6ThecompositeProfitabilityIndexismadeupoffiveratios that each represents adifferentaspectofacompany’sprofitability.FormoreinformationontheBarometermethodology,pleaserefertothelastsectioninthisreport.




tooperatingrevenuesincreasingfasterthanmaterialcostsfrom2006to2009,contributingtohighergrossmargins.

Indeed,ofthefivesectorsthattheEIUstudiedforthisBarometer,thePEindustryistheonlyonewhereprofitabilitycontinuedtogrowuninterruptedthroughthelastglobaleconomicslowdown.CombinedoperatingrevenuesincreasedfromUS$26.6bnin2007toUS$33.5bnin2008andUS$35.1bnin2009.ThissuggeststhateventhoughmanufacturingexportstodevelopedWesterncountriesdeclinedduringthisperiod,thiswassomewhatoffsetbyindigenousAsiandemandaswellasgrowthinnewmanufacturingsegments.Forinstance,Asia’sproductionofsolarPVcellsincreasedsignificantlyinboth2008and2009.Additionally,AsianmanufacturersmayhavecontinuedtoinvestinPEmachineryinanticipationoffuturedemand.

Inthecomingyears,MrThamatAppliedMaterialsexpectstosee“growthopportunitiesinthesemiconductorindustrypropelledbythewirelessandmobilemarkets,asconsumersdemandanincreasinglynetworkedsocietywithvisuallyrichandinteractivedevicesanytime,anyplace”.Heexpectsasurgeinconsumptionfromtheemergingworld’smiddleclassasproductsbecomemoreaffordable.However,profitabilitywilldependnotonlyonglobaleconomicgrowth,butalsooncostsandtechnology.MrThambelievesthatcompanieswillneedtocontinueinvestinginR&Dtoproducenewertechnologiesatcheapercosts.




Case study: World Precision Machinery

World Precision Machinery: Moving up the technology ladderWorldPrecisionMachinery(WPM),anintegratedmanufacturerof

precisionmetalstampingmachinesbasedinJiangsu,China,hasseenitsrevenuesmultiplyfive-foldbetween2005and2010.Inthefirstninemonthsof2011,thefirmhadrevenuesofRMB947.9m(US$150.1m),amountingtoyear-on-yeargrowthof30%.

ShaoJianJun,thecompany’sexecutivedirectorandCEO,saysWPMderivesmorethan95%ofitssalesfromChinacurrentlyandthatAsia’sstandingastheworld’smanufacturinghubwillcontinuetopresentbusinessopportunitiesforthecompanyas“thestampingindustryformsthebackboneofmanymanufacturingindustries”.WPMiscurrentlyoneofthethreelargestmanufacturersofmetalstampingmachinesinChina.Itmostlysuppliesmanufacturersinhomeappliances(34%ofrevenues),automobiles(32%)andelectronics(15%),whileitearnstherestofitsrevenuefromseveralothersectors.

MrShaoattributestheprofitabilityintheindustryto“aboominmarketdemand,[therisingvalueof]brandnames,pricecompetitivenessandtechnologyinnovation”.However,headds

thattheintensityofcompetitioninthesectorinAsiahasincreasedconsiderably.“MoreandmoremanufacturingplantshavemovedintoAsia,”hesays.Manynon-Asianfirmshavesetupplantsintheregioneitherindependentlyorthroughjointventures.Forinstance,globalplayerssuchasKLA-TencorandAppliedMaterialshaveinvestedinmanufacturingplantsandresearchandsupportcentresindestinationssuchasChina,India,Malaysia,SingaporeandTaiwan.

MrShaoexpectsstiffcompetitioninthePEsectoroverthenextfewyears.HesaysthatAsianfirmshavestartedtomoveupthetechnologyladder,whilenon-AsianfirmsthathaveanAsianpresencehavestartedloweringproductioncosts.

Inthefaceofthisrisingcompetition,akeypartofWPM’sstrategyisverticalintegration:thecompanyhasthecapabilitytodesign90%oftheequipmentitproduces.AccordingtoMrShao,overthenextfiveyears,profitabilityinthePEindustrywillbedrivenbymarketdemandontheonehand,andcostcontrol,productionefficiencyandpricecompetitivenessontheother.Technologyinnovationwillalsobeimportant,hesays.ThisisreflectedinWPM’sdecisiontoemploymorethan200R&DandtechnicalstaffintwoChinesecities,DanyangandShanghai.




Figure 6: Private consumption(% real growth p.a.)

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Positioning for success in Asia

Sustained growth in Asia

Giventhelong-termstructuralproblemsinmanyWesternmarketsandemergingAsia’slargelybullisheconomicfundamentals,theshiftintradeandinvestmentfromtheWesttoAsiawillcontinue.Asia’s

economicgrowthisexpectedtocontinueoutpacingthegrowthofOECDcountries.TheEIUestimatesthatby2016theeightAsiancountriesinthisstudyalonewillaccountfor28.9%ofglobalGDP(measuredinpurchasing-powerparityterms),upfrom23.2%in2010.

AcriticalquestionforAsia’smanufacturingandPEindustriesiswhethertheriseinAsiandemandcanoffsetthesluggishgrowthindevelopedWesternmarkets.China’smerchandiseexportstoEuropefell7.5%month-on-monthinSeptember2011and9%inOctober2011whileitstotalexportsdeclinedby7.2%inthatmonth.China’spurchasingmanager’sindex,aproxyformanufacturingsectorperformance,declinedforthefirsttimeinthreeyearsinNovember2011,registeringasub-50reading,denotingacontractioninfactoryactivity.Itstayedbelow50inDecember2011andJanuary2012.Meanwhile,thecrisisintheeurozonecountriesandtheslowrecoveryintheUSsignificantlyraisetheriskofaglobal




Figure 7: Device penetration levels(%)

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150WorldWest EuropeNorth AmericaAsia & Australasia

PCs (per 100)Mobile subs (per 100)


recession,accordingtotheEIU.Weestimatethereisagreaterthan40%chancethattheglobaleconomywillfallintorecessionsometimeinthenexttwoyears.

Nevertheless,ourcoreforecastassumesthatprivateconsumptioninAsia,particularlyChina,willcontinuegrowingstrongly(seeFigure6).

Still,itremainstobeseenifthatgrowthwillbeabletooffsetthelikelyslowdownindemandintheWestoverthenextfewyears.ThereisalsoariskacrossmanysectorsinAsia,fromrealestatetoshipbuilding,ofanoverinvestmentincapacityoverthepastfewyears.IfmanufacturershavesimilarlyoverinvestedinPEmachinery,thePEindustrymayhavetocontendwithseveralyearsofslowgrowth.

WhilestillvulnerabletoaslowdownintheWest,Asia’sPEindustryhasbecomeincreasinglydependentonrisingprivateconsumptionintheregion.IfAsia’seconomiesshouldstumble—hurtingemploymentandincomegrowth—thatwouldhaveanegativeimpactontheregion’sPEindustry,asconsumersarelikelytoquicklycutbackondiscretionarypurchases,suchasnewmobilephonesandbettercars.

Semiconductors and solar: Asian growth storiesThegrowingdemandforpersonalcomputers,mobilephones,tabletsandotherconsumerelectronicsinAsiahasbeenamajordriverofthesemiconductormarket.Asiaex-Japan’sshareofglobalsemiconductorsalesincreasedfromabout40%in2004tomorethan50%in2009,accordingtotheSemiconductorIndustryAssociation,highlightingthegrowingimportanceofAsiatothissegmentofthePEindustry.7

In2010,theglobalsemiconductormarketgrewbyUS$72bnor31.8%,withAsiaaccountingformorethanhalfofthatgrowth(salesintheregionincreasedbyUS$40.4bntoUS$160bn).Despitethedarkeningglobaleconomicoutlook,andtherelatedmoderationofAsia’sgrowthforecasts,theEIUexpectsthemarketsforconsumerelectronics,mobilehandsets,smartphonesandpersonalcomputersinAsiatogrow,albeitpossiblyatamoregradualrate(seeFigure2).

Indeed,comparedtodevelopedregions,thepenetrationofthesedevicesinAsiaisstilllow(seeFigure7).

Thissuggeststhatthereisstillplentyofroomforcatch-upgrowth.ThusthesemiconductorindustrycanexpecttoseecontinuedgrowthinAsiaand,byextension,socansemiconductorequipmentmanufacturers.Asiahasbecomethemostimportantmarketforcompaniesinthisspace.

Additionally,semiconductormanufacturersrelentlesslyinvestinnewtechnologyinordertolowertheunitcostsofprocessingpower.“Consumerend-demandforelectronics,mostrecentlyinsmartphonesandtabletcomputers,hashistoricallydrivencompetitioninourindustrytomakefaster,morecomplex,andcheapersemiconductorsinlinewithMoore’slaw,”saysMrThamatAppliedMaterials.8 HecitestheiPodasanexample.AniPodbuiltinthe1970satthecost-per-transistorthenwouldhavecostUS$3.2bnandwouldhavebeenthesizeofahouse;however,withinnovationinlinewithMoore’slaw,todayaniPodcostsUS$250andfitsintoapocket.

7GlobalSalesReport.SemiconductorIndustryAssociation.Variousyears

8Moore’slawisnamedafterGordonMoore,co-founderofIntel,acomputerchipmanufacturer,whopredictedthatcomputerprocessingpower—measuredbythenumberoftransistorsonanintegratedcircuit—wouldriseexponentially,doublingevery18monthsorso.




Whatistruehereofsemiconductorsisalsotrueofsolarpanels,saysMrTham.“Astheindustryreducesthecost-per-wattresultingincheapersolarpanels,competitionwilldrivepricepressuresandpotentiallyresultinconsolidation,”hesays.Despitetherecenthiccupsintheindustry,MrThamexpectssolarenergytobecomeaviablealternateenergysource.“InnovationsbyPEcompaniescreatemanufacturingsolutionsthathelpPVproducerspushdownthecost-per-watt,andwilleventuallymakesolarenergycostcompetitivewithtraditionalenergysources.”

InMrTham’sview,mostglobalplayershaveacknowledgedtheimportanceofAsiaasanimportantsemiconductorandsolarmanufacturingbaseandthereis“anemergingpreferenceoftheindustrytohavealargerandmoresignificantpresenceinAsia”.




Case study: Applied Materials

Applied Materials: Continued growth in AsiaAppliedMaterials,withrevenuesofmorethanUS$10bnin2011,is

theworld’slargestsupplierofmanufacturingequipmentandservicesforthesemiconductor,flat-paneldisplayandsolarindustries.“About75%ofourrevenuecomesfromAsia,upfromabout50%adecadeago.WehaveasignificantpresencethroughoutAsiainChina,Taiwan,Singapore,India,JapanandSouthKorea,andarecontinuingtogrowourfootprintintheregion,”saysRussellTham,regionalpresidentofAppliedMaterialsSouthEastAsia.

SinceestablishingitselfinAsiamorethan20yearsagowithsalesandtechnicalsupportfunctions,MrThamsaysthatthecompanyhasadded“strategicandoperationalrolestocatertoamarketbasethatisshiftingtoAsia,andtoimprovecostcompetitiveness.”

“CompetitiontokeepupwithMoore’sLaw,whichdrivesincreasinglyadvancedsemiconductors,hasresultedinatrendofconsolidationforoursemiconductormanufacturingcustomers,aswellaseverincreasingcapitalinvestmentrequiredtoachievetheprofitableeconomiesofscale,”MrThamsays,inexplainingthehighinvestmentbarriersinvolvedinthesemiconductorindustry.

HebelievesthePEsectoritselfisincreasinglycapitalintensive,particularlywiththedevelopmentoftechnologiessuchasthree-dimensionalintegratedcircuits,whichrequire“significantRD&E[research,developmentandengineering]resourcesandinvestmentthatareonlyavailabletoglobalplayers.”MrThamsuggeststhatcompetition-drivenconsolidationamongthePEindustry’scustomerscouldleadtoasimilarconsolidationinthePEindustryitself.InMay2011,AppliedMaterialsacquiredVarianSemiconductorforUS$4.9bnandinNovember2009,itpaidapproximatelyUS$364mtobuySemitool,anothersemiconductorcompany.Similarly,waferfabricationequipmentsupplierLamResearchagreedtobuyrivalNovellusSystemsforUS$3.3bninDecember2011.

Togainacompetitiveadvantage,saysMrTham,PEcompanieswillhavetoinvestinR&D“toaddressanincreasingnumberoftechnologyinflectionpointsinordertoenableMoore’slawandproducenewertechnologiesatevercheapercosts.”Headdsthattheseinnovationswillinvolvenewmaterials,uniqueintegratedcircuitdesignarchitectures,novelpatterningstructuresandlargersubstrates.“Thetrendofglobalisationhasalsoseencompaniesoptimisetheirglobalfootprintthroughthedevelopmentoflowercostoperationsandsupplychains,especiallyinAsia,”headds.




Outlook

Overthepastdecade,Asia’sPEindustryhasexpandedintandemwiththeregion’smanufacturingsector.ThenumberandsizeofAsianPEcompanieshasincreased,whilemanyhavebroadenedthe

scopeoftheiroperationsbyenteringnewsegmentsaswellasbyintegratingvertically.SeveralAsiancompaniesrecordedlargeincreasesintheiroperatingrevenuesbetween2004and2009.Forinstance,theannualturnoverofLarsen&Toubro,anIndiantechnology,engineering,manufacturingandconstructionfirm,increasedfromUS$3.4bnin2004toUS$9.5bnin2009.

Fortheindustryasawhole,afteraslightdipinprofitabilityin2005-06,marginshaverisensteadily.Inparticular,bigcompanieshavebeenabletoexploiteconomiesofscaleandgrowrapidly,bothorganicallyandthroughmergersandacquisitions.Withongoingconsolidationintheindustry,itseemslikelythatthebiggerfirmswillcontinuetogrowtheirmarketshare.

Theindustry’soutlookoverthenextfewyearshingeslargelyontwotrends—themergingofAsianandnon-AsianPEbusinessmodels;andtheshiftindemandfromtheWesttotheEast.First,asAsia’smarkethasgrown,morenon-Asianglobalplayershaveenteredtheregion.“Overthenextfewyears,theAsianfirmsandnon-Asianfirmswillcompetewitheachotherintermsofpriceandtechnologycompetitiveness,costcontrolandproductionefficiency,”MrShaoatWorldPrecisionMachinerysays.Therefore,evenasAsia’slargestPEfirmsarewinningmarketsharefromsmallerAsianplayers,theyincreasinglyhavetocontendwithnon-Asiangiantswhoareloweringtheircostsofproductionandbroadeningtheirfootprintsacrosstheregion.TheindustryisthuslikelytobecharacterisedbyfiercecompetitionbetweenbigAsianandnon-Asianplayers,whomayincreasinglyresembleoneanother.

Second,Asianmanufacturers—and,byextension,thePEfirmstheydependon—areseeingademandshiftfromdevelopedWesternmarketstotheemergingworld,particularlyAsia.Risingdisposableincomesintheregionhavedrivenexponentialgrowthinthemarketsforarangeofconsumerproducts,fromautomobilestotabletcomputers.AsianPEfirmsarebecomingincreasinglydependentontheseboomingAsianmarketsfortheirgrowth.Theirsuccessoverthenextfewyearswilldependonhowaccurately




theyhaveplannedforandmanagedthisshift,particularlygiventhebroaderglobalmacroeconomicuncertainty.Overthelongerterm,Asia’sseculargrowthstorywillensurethatitsPEindustrycontinuestogrowrapidly.




Barometer methodology

Toassesstheintensityofcompetitionandunderstandthechangingmarketdynamicsinkeysectors,theEconomistIntelligenceUnithasdevelopedtheAsiaCompetitionBarometer.Drawinguponcompany-

leveldataonprofitabilityandotherindicators,theBarometerquantifiesthechangingdynamicsofcompetitivenessinAsiaforselectindustriesbetween2004and2009.

Assessingauniverseofover200publicly-listedprecisionengineering(PE)companiesacrosseightcountries—China,India,Indonesia,Malaysia,thePhilippines,Singapore,ThailandandVietnam—theBarometerexamineschangingprofitabilityandthecompetitionlandscapeforthePEsector.

How do we define the precision engineering sector? ThePEsectorincludesthemanufactureof:

Instrumentsandappliancesformeasuring,testingandnavigation,irradiation,electromedicalandelectrotherapeuticequipment,opticalinstrumentsandphotographicequipment,power-drivenhandtools,metal-formingmachinery,othermachinetools,otherspecial-purposemachinery,airandspacecraftandrelatedmachineryandmedicalanddentalequipmentandsupplies.

Methodology TheBarometerhastwodimensions:profitabilityandmarketconcentration.

Profitability IndexToassesstheaggregateprofitabilityofthePEinAsia,theEconomistIntelligenceUnitdevelopedacompositeindexoffiveratiosthateachrepresentadifferentaspectofacompany’sprofitability:

• EBITDA margin (%):Ameasureofacompany’soperatingprofitability.Itisequaltoearningsbeforeinterest,tax,depreciationandamortisation(EBITDA)dividedbytotalrevenue.BecauseEBITDA




excludesdepreciationandamortisation,EBITDAmarginprovidesaclearerviewofacompany’scoreprofitability.Anincreaseincompetitionmayputpressureonanindustry’sprofitmargins.

• Gross margin (%):Whenusedasamarketmeasureofcompetition,grossmarginmeasurestheprofitabilityconsideringonlythecostsofgoodssold.Thehigherthepercentage,themorethecompanyretainsoneachdollarofsalestoserviceitsothercostsandobligations.Anincreaseincompetitiontendstoreducefirms’abilitytoincreasepricesandtherebyincreaseitsgrossmargin.

• Return on capital employed (%):Ameasureoftheefficiencyandprofitabilityofacompany’scapitalinvestments.Returnoncapitalemployedalsoindicateswhetherthecompanyisearningsufficientrevenuesandprofitsinordertomakethebestuseofitscapitalassets.Anincreaseincompetitionmayrequirefirmstoemployadditionalcapitaltomaintainprofitability.

• Return on equity (%):Ameasureoftherateofreturnontheshareholders’equity.Itmeasuresafirm’sefficiencyatgeneratingprofitsfromeveryunitofshareholders’equity.Returnonequityshowshowwellacompanyusesshareholderfundstogenerateearningsgrowth.Ariseincompetitiontendstoputpressureonreturnsonshareholderfunds.

• Return on assets (%):Ameasureofhowprofitableacompany’sassetsareingeneratingrevenue,orhowprofitableacompanyisrelativetoitsassets.Returnonassetsdeterminesacompany’sabilitytoutiliseitsassetsefficientlyandeffectively.Highercompetitiontendstoputpressureonfirms’abilitytomaintainreturnonassets.

Weaggregatedcompany-leveldataformorethan200publicly-quotedPEcompaniesandexaminedtheirprofitabilityratios.Toenableobservationoftrendsovertime,acompositeProfitabilityIndexwasdeveloped(whereyear2005=100).EBITDAandgrossmarginaregivenahigherweightingintheindexastheyspeakdirectlytobottomlineprofitability,whilethereturnoncapitalemployed,returnonequityandreturnonassetsratiosspeaktohowacompanymakeuseofitsvariousresourcestodrivereturn(i.eefficiency/productivity).

Profitability indicator Weight in Profitability Index

EBITDAmargin(%) 35%

Grossmargin(%) 35%

Returnoncapitalemployed(%) 10%

Returnonequity(%) 10%

Returnonassets(%) 10%

Market concentration Toassessmarketconcentration,theEconomistIntelligenceUnitcalculatedtheHerfindahl-HirschmannIndex(HHI)forthePEsectorinAsiafrom2004to2009.Ameasureofthesizeofcompaniesinrelationtotheindustry,andanindicatoroftheamountofcompetitionamongthem,theHHIisdefinedasthesumofthesquaresofthemarketsharesofthe50largestfirmsfromtheuniverseofover200listedcompaniesassessed.9HHIvaluescanrangefrom0to1.0,movingfromanextremelyfragmentedmarket(0)toa

9Orsummedforallthefirmsin the case that there are fewerthan50.




monopoly(1).HHIvalueshavebeenmultipliedby100toachieveascaleconsistentwithprofitabilityindicators.ArisingHHIindexgenerallyindicatesfallingmarketcompetition,whileafallintheHHIsuggeststhatcompetitionisincreasing.


Whilst every effort has been taken to verify the accuracy of this information, neither The Economist Intelligence Unit Ltd. nor the sponsor of this report can accept any responsibility or liability for reliance by any person on this report or any of the information, opinions or conclusions set out herein.

asia competition barometer - precision engineering (economist intelligence unit. 2010)

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