By Luigi Gigliotti, Dorothee Herring, Fabian Newger, and Thorsten Schleyer
The European machinery industry has experienced unprofitable growth for several years due to a variety of challenging circumstances, including declining productivity, rising material cost, and growing product complexity. The COVID-19 pandemic exacerbated the industry’s distress and exposed a lack of resilience. With some notable exceptions, machinery companies experienced declines in both revenues and profits in 2020.
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Although performance varies by region and company, the industry overall must transform itself—not only to navigate out of the downturn but also to chart a promising path forward. Companies can explore opportunities to complement their core capabilities to address customers’ evolving expectations and needs, expand their capabilities beyond the core to compete in adjacent markets, or find ways to meet the machinery needs of new categories, including those arising to meet sustainability goals.
This article examines the industry’s structural challenges and the variances in performance by region and type of company. It also provides an example from the automotive industry to show how a machinery company could revive its fortunes by making structural changes.
Structural challenges in the industry
Even before the global pandemic, the European machinery industry had a profitability problem (Exhibit 1). Although the industry grew from 2016 to 2019, average profitability shrank by 130 basis points (bps). The exact reasons for downward pressure on margins varied by country and company but generally involved some combination of the following:
- increasing product and solution complexity caused by a rapid increase in software development or company moves into smaller, niche segments; this complexity makes it harder to attain scale benefits in R&D and material cost, despite growth
- productivity gains that significantly lag behind other industries—again, due to rising complexity—and fail to offset rising salaries
- decoupled businesses in which R&D and production take place in high-cost countries, while revenues come from more physically distant, lower-cost countries where margins are thinner
- price-eroding competition in markets that are the primary source of growth
- declining product differentiation relative to global competitors, resulting in rising costs, capital expenditures, and complexity that customers do not perceive as warranting higher prices
- the continued overreliance of many companies on selling hardware rather than shifting toward integrated solutions
The COVID-19 pandemic compounded the pressure on machinery companies, but it also created important opportunities to restructure the industry and accelerate its digital transformation.
Regional differences in performance
Revenues for Europe’s machinery industry declined 5.6 percent in 2020, and margins dropped by 1.8 percent. (While severe, these full-year losses were less than industry observers had anticipated at the midyear point.) But these totals also belie some notable regional differences.1 While the revenues of Swiss and German companies fell by about 8 percent, those of their Nordic2 peers fell by only 2.4 percent.
Margin loss differences were even starker. The Nordics, which enjoyed the highest average margin of 11.7 percent coming into 2020, lost 100 bps, continuing a slight trend of decline. Switzerland also lost 100 bps but was starting from a lower base of 8.5 percent—and had previously been enjoying a trend of slight improvement. Germany began with the lowest margin base of 6.7 percent and lost the most (330 bps), accelerating a multiyear trend.
Factors contributing to these losses also varied. For example, Nordic companies benefited from higher aftermarket and service shares of revenue, which increased their resilience.
Company differences in performance
At a minimum, most companies faced a dramatic drop in demand in 2020 (Exhibit 2). Beyond that, the effects tended to mirror those of the industries they serve. For example, the demand drop was especially pronounced for companies supplying materials to the automotive and aerospace industries directly or indirectly, as in the case of short-term capital goods such as machine tools. By contrast, companies supplying the food and beverage or e-commerce and logistics industries fared much better.
Additionally, lockdown restrictions prevented some companies from producing equipment at their facilities or sending service personnel to customer sites for equipment installation and maintenance.
In a reversal of a recent trend, project-engineering companies fared much better than product-focused machinery companies, in part because their projects have longer lead times. Many project-engineering companies enjoyed full order books at the start of 2020, which helped them weather the crisis even as demand shrank.
Other factors contributed to the relative success of some companies. Those that grew in 2020 adopted a similar approach, targeting opportunities in energy transition and sustainability in areas such as wind power, sustainable packaging, energy-efficient tools, and heating, ventilation, and air-conditioning systems. They also played globally; for example, they engaged the Chinese market, which recovered faster than other markets.
Multiple companies that had been in distress before the crisis but embarked on successful restructuring programs avoided further declines in 2020 or even improved results over 2019.
Several companies also cut costs sooner than others—as early as January—and more deeply than turned out to be necessary when China recovered faster than expected. This combination of cost cutting and a revenue windfall (a rebound of more than 50 percent in some cases) enabled these companies to cover fixed costs and weather the storm.
Others benefited from a modernized business model. This includes companies with a sizable digital-product portfolio and a substantial commitment to sustainability across the organization and product portfolio. It also includes companies whose aftersales are driven by customers’ requirements to comply with maintenance regulations and companies that have a high share of variable costs and benefited from falling prices on raw materials. Multiple companies that had been in distress before the crisis but embarked on successful restructuring programs avoided further declines in 2020 or even improved results over 2019.
Toward a brighter future
Additional performance-improvement levers are hard to find and will be insufficient to overcome hurdles such as declining differentiation. Only structural changes aimed at reinventing the value proposition will position companies to profitably grow. Companies may complement their core capabilities with new ones that increase customer value. For example, customers may place a premium on digital solutions designed with the end customer in mind or on solutions that support their sustainability agendas. Or they may opt to expand their core capabilities to compete in adjacent growth areas.
Consider a machinery company whose revenues are highly concentrated in the automotive industry (Exhibit 3). Several shifts taking place in the industry seem, at first glance, to threaten machinery suppliers. In a trend called “peak car,” overall auto sales hit their apex and have begun to decline. Additionally, many machinery players are affected by the accelerating e-mobility trend and a declining demand for traditional powertrain components. OEMs are launching programs to reduce capital expenditures to free up cash for investment in emerging technologies.
Concurrent with these trends, however, the automotive industry is attracting many new entrants, such as new battery-electric-vehicle (BEV) OEMs, mobility operators, and a wide range of transport and logistics start-ups. All these companies’ business models rely on vehicles of some sort (from cars to trucks to off-road equipment) for the transportation of people or goods. This, in turn, creates opportunities for machinery companies to leverage their core capabilities to supply a new customer base.
Further beyond their core, companies may find attractive adjacencies. For example, battery-cell production is increasing in Europe. Machinery and automation companies can study the category’s value chain to identify demand they can meet with their core capabilities—for example, for coating and assembly. Indeed, new sustainability initiatives more broadly are apt to open doors for machinery companies as demand grows for hydrogen fuel cells, energy storage, biofuels, recycling services, and much more.
Of course, tapping new growth opportunities requires much more than ideas and capabilities; it requires organizational transformation to drive innovation and growth.