Perspectives on Manufacturing Industries 2/2012 by Oliver Wyman Group

Perspectives on manufacturing industries issue 2/2012

91%

of the executives of investors and other 足companies surveyed by Oliver Wyman believe that if another economic crisis occurs, it will 足 be more serious than the one in 2008/2009. 足 Thus, preventing and managing crises are increasingly important issues that corporate owners and management must address. Cover story on the restructuring study, page 6

editorial

Dear Reader, The machinery and plant engineering industry in Western Europe successfully managed the 2008/2009 crisis. Many companies saw their revenue and profitability quickly return to pre-crisis levels. But the economic environment has changed. For some time now, high forecast uncertainty and pronounced volatility have no longer been transient phenomena, but a permanent state of affairs that every company needs to adapt to. Furthermore, there is growing uncertainty about the direction of the economy. As a result of the continuing financial market crisis and new regulations such as Basel III, the requirements for access to capital are becoming stricter – especially for companies that have poor business figures, operate in a difficult market environment or use a business design that is fraught with risk. These are the f indings of Oliver Wyman’s most recent restructuring study, which is treated in greater detail in the cover story of this issue of Perspectives. The study describes what companies must do to prepare for a possible downturn and how they can secure the trust of their capital providers.

Thomas K autzsch Head of Oliver Wyman’s Manufacturing Industries Practice

We also asked Sven H. Jezoreck of Deutsche Bank to tell us how companies and banks are challenged by the economic situation, financing and crisis management. He emphasized that if we all expect another crisis and are prepared to respond quickly and appropriately to changes, it will not take on the dimensions of the one in 2008/2009. I hope you find this publication interesting and thought-provoking. Best regards,

Thomas Kautzsch 3

content

Cover story Sustainable Crisis Management

RESTRUCTURING INSTEAD OF DOWNSIZING

External perspective Interview with Sven H. Jezoreck, Deutsche Bank AG

“Having a flexible business model makes a difference“

Markets Euro Crisis

PREPARING FOR THE NEW NORMAL

Connected Trucks

THE TIME HAS COME

Wind Energy

Grow or Go

The Solar Industry

THE END GAME IN PHOTOVOLTAICS

Commentary SUCCEEDING THROUGH SUSTAINABILITY 20

Operations Research & Development

TACKLING TOMORROW’S CHALLENGES 22 Production

STRATEGICALLY OPTIMIZING INDIRECT PROCESSES

Publications The Oliver Wyman Risk Journal

MAXIMIZING RETURNS ON LARGE INVESTMENT PROJECTS

RESTRUCTURING INSTEAD OF DOWNSIZING Sustainable Crisis Management

Companies are faced with a multitude of challenges: growing uncertainty about the future of the economy, shifting markets, fiercer competition, and the increasing demand f or access to capital, to name a few. To prevent and manage future crises, a company’s owners and management must develop and implement long-term strategic, business design, and operations measures. These are the findings of Oliver Wyman’s study “Restructuring Instead of Downsizing – Success Factors for Sustainable Crisis Management.” Persistent uncertainty about the future economic cycle and changing market and competitive environments make it increasingly likely that crises will occur more frequently. However, after having successfully recovered from the crisis years 2008/2009, the majority of German companies are optimistic about the future.

More pronounced cyclical fluctuations

If there is another economic crisis, will it be more serious than the one in 2008/2009?

Yes 91% No 9%

The stronger cyclical fluctuations that can be seen today can be traced back to growing globalization and increasingly networked processes along the supply chain. Therefore, it is important for all companies, and especially those in industries that are particularly vulnerable to changing economic conditions, to prepare themselves for different economic scenarios. Almost 90 percent of the companies and investors surveyed for the study think that the euro crisis poses a threat to Germany’s economic development. And more than 90 percent of the respondents believe that if another economic crisis were to occur, it would be much more serious than the one in 2008/2009. In their opinion, this is because today loans are less readily available; foreign markets, in particular BRIC countries, cannot compensate for the business lost to the extent they did in the past; companies have already fully exploited their cost-reduction potential; and governments cannot provide as much support.

Change as an opportunity For some time now, markets and competition have been in a state of per manent change. As a result, many industries are facing major challenges,

Cover story

e specially the renewable energy sector, machinery and automotive companies and the retail industry. When asked to identify and assess current market changes, the majority of the executives interviewed said that price pressure had become more severe. Furthermore, the respondents believe that geographical shifts – particularly to China and emerging markets – constitute an important trend. Increasing productivity, globalizing the value chain, and improving innovative ability are essential if companies are to benefit from these market shifts, not least because these factors secure market access and make it possible to supply the right products at compet itive prices. Most of the surveyed companies believe that the changes in the market and competitive environment should be understood as opportunities. Benchmarks established during the study reveal that, compared with other international companies, many German enterprises have an excellent position in the market and sound financial resources. Thus, they are well equipped to turn these new developments into an advantage. Only one-third of the companies see the changes as a threat. The study shows that companies and investors must have an in-depth understanding of the trends in a specific market and competitive environment if they want to avoid risks and make the most of the developing opportunities.

Growing requirements In the years to come, many companies will have a substantial need for capital. However, the rules governing corporate financing will be different. Banks have become more sensitive to risk, and their creditworthiness assessments have become stricter. Of the financiers interviewed, 64 percent said that the approval processes had become more demanding, and 44 percent stated that loans require higher collateral. Moreover, investors are analyzing different risks than in the past. Of the respondents, 54 percent are investing more time and resources in analyzing a company’s market environment and positioning. And 46 percent are carrying out more futureoriented creditworthiness assessments. The study gave no indication of a credit crunch. Only a small minority of the investors surveyed had decided to reduce or terminate their investments early.

What factors could aggravate a possible new crisis? Participants could select more than one response Loans are not as readily available 52% Foreign markets (esp. BRIC) cannot compensate for the business lost to the extent they did in the past 52% Companies have fully exploited their cost-reduction potential 41% Governments cannot provide as much support 40% Consumers respond more sensitively 29% Companies are more vulnerable because of their lower equity capital base 24% Workers' representatives and unions are less cooperative 21%

ABOUT THE STUDY The study “Restructuring Instead of Downsizing – Success Factors for Sustainable Crisis Management“ was carried out during the first six months of 2012 in German-speaking countries. More than 100 executives of investment and other companies from various industries with differing ownership structures were interviewed online. The majority of the companies represented were medium sized and posted a profit in 2011. The study comprises the responses of the surveyed financiers and companies, and is supplemented by opinions and analyses of Oliver Wyman. It provides suggestions on how to successfully and sustainably master corporate crises.

Today, the investors’ belief about a company’s business prospects plays an even stronger role in the provision of capital than in the past. Of the f inanciers interviewed, 90 percent said that they put higher demands on companies with a poor outlook. By contrast, only 47 percent said the same for companies with a promising future.

Rising cost of capital Basel III will lead to growing capital costs and tie up a company’s collateral. At the same time, there will be a larger number of financing parties. In addition to traditional commercial banks, institutional investors play a bigger role. These include insurance companies, equity funds, and hedge funds that invest in minority stakes, subordinated capital, or bonds of companies. Whether or not a loan is granted also depends on an intensive risk assessment on the part of investors. Basel III will especially affect companies with poor creditworthiness, a highrisk market environment, and an unconvincing business design. Because of increasingly future-oriented internal bank ratings, these companies will score lower values, which may lead to liquidity bottlenecks. Higher costs of capital not only burden cash flow but also hinder access to capital and reduce the capacity for new loans. Thus, due to Basel III, it is increasingly important that companies find a suitable form of communication to assure the investors’ trust.

New evaluation criteria Current compared to past investor demands Number of mentions in % of the investors surveyed

On companies with good prospects Higher 47% Lower 7%

Unchanged 46%

Investors apply interesting criteria for assessing a company’s business prospects. Traditional factors such as current or historical financial data, transparency, and trust in the company’s partners remain high up on the list. However, for 70 percent of the surveyed financiers, these aspects have been overtaken in importance by the company’s financial plan for the coming years, as well as the strategy, and business design relative to its market and competitive environment.

An open dialog Companies with a need for capital are called on to develop strategies that avoid risks and unlock the potential of their specific market environment. These strategies must be communicated clearly and convincingly to investors. Furthermore, companies must prepare measures for different economic scenarios, so that they will be equipped to respond to impending crises more holistically, proactively, and at an earlier stage. Measures targeting strategic and operational restructuring play a prominent role in this.

On companies with poor prospects Unchanged 10%

Higher 90%

Cover story

Sustainable crisis management Standard tools for achieving a short-term turnaround such as headcount reductions, working capital cuts, and working-time model adjustments are still important for managing through the next crisis. But the study participants doubt that these short-term measures will achieve long-term restructuring success. Such quick cost-reduction measures were applied during the most recent crisis – but if another crisis should arise, these measures will largely be replaced by measures designed for the long term. Of the companies

s urveyed, 45 percent believe that strategic realignment will be much more important for overcoming a future crisis than it was in the past. And 64 percent say the same for portfolio optimization. Furthermore, in operational restructuring, companies are putting a stronger focus on production relocation, process optimization, and product-cost reductions.

Criteria for evaluating a company‘s prospects before deciding to make a loan or investment Number of mentions in % of the investors surveyed, deviations from 100% may occur due to rounding

A powerful team

The study participants believe that this places new demands on a restructuring consultant. In addition to cost-reduction and financing know-how, he or she needs to have an in-depth industry understanding as well as methodological expertise in strategy development and operational optimization. He or she must also be able to act as a mediator between the interests of the financial parties. Both companies and investors believe that it is important to appoint a Chief Restructuring Officer (CRO) to ensure the success of complex restructuring efforts. However, 70 percent of the study participants say that the CRO and the restructuring consultant should not be from the same company. Rather, they should come from independent partners and form a powerful and effective team. The long-term success of a restructuring effort hinges on these four elements: a coherent strategy, a robust business design, a financing concept that is aligned with both, and possibly external support to meet the diverse competence needs.

9% 28%

Yes, in the role as advisor

Yes, with executive responsibility

16%

18%

76% 55%

Company

Investor

Lutz.Jaede@oliverwyman.com +49 89 939 49 440

Criteria for evaluating a company‘s prospects before deciding to make a loan or investment Number of mentions in % of the investors surveyed, deviations from 100% may occur due to rounding 25%

74%

Financial plans for the next years 5%

22%

72%

Strategy and business design 2%

31%

67%

Financial data of the current fiscal year 9%

24%

67%

Market environment and competitive position 2% 9%

22%

67%

Trust in management 17%

47%

36%

Historical financial data 2%

14%

51%

33%

Transparency within the company 4%

21%

48%

27%

Trust in partners 50%

50%

Others 1 (not important)

4 (very important)

“Having a flexible business model makes a difference“

Mr. Jezoreck, most of the executives interviewed for our survey believe that another economic crisis would be much more severe than the crisis in 2008/2009. How do you think the economy will perform in Germany and Europe?

Sven H. Jezoreck Chairman of the Management of the Ruhr and Münsterland Region, Corporate Banking Germany, Deutsche Bank AG

At first glance, I was surprised by the survey results because, at the moment, we are not seeing any signs of this at the macroeconomic level. But your f indings can also be seen in a very positive light. They show that executives have become more wary and are proceeding more cautiously. Many companies are now in very good shape in terms of their order books and employment levels. Furthermore, enterprises are in a substantially better position when it comes to operating income, liquidity and equity capital ratios than in 2008. Therefore, I am very optimistic overall: If everyone expects another crisis and is prepared to respond quickly to changes, the next crisis will hopefully not take on the dimensions of the one in 2008/2009. What factors might aggravate a possible new crisis? What are the major risks? Exogenous shocks may occur and negatively impact the economy. The rapidly increasing debt levels in Europe, for example, constitute a serious threat. At the moment, however, this issue is not quite as critical as in the past. However, it remains to be seen whether this will also hold true in the long term. Which industries do you think are at high risk from economic developments? Industries that are early in the cycle should remain especially vigilant. utomotive manufacturing, because of its value chain, is one of the industries A that needs to react quickly. This also applies to some mechanical engineering companies, for example, manufacturers of printing machines, as these are usually among the first to be affected by a slump in the economy. Companies in these industries should be prepared well in advance and adapt their business models as flexibly as possible to today’s high market volatility.

External perspective

Unfortunately, this is more difficult in a number of other industries, such as plant engineering. In general, though, I am optimistic because companies that survived the last crisis and did their homework are now much better equipped than they were in 2008. Basel III still has quite a lot in store for us. Have banks raised their lending criteria over the past few years? Many of the stricter regulations are still subject to change, and at this stage, it is not yet possible to precisely quantify their impact. However, all banks in Germany and Europe are facing new challenges. They are being forced to take a closer look, increase their equity capital ratios and adapt their lending procedures. Germany, though, is far from experiencing a credit crunch. The market is still very robust, and sufficient capital is available – not least because the demand for credit has declined. Nevertheless, companies should be thinking about securing their long-term financing, especially now. They need to implement systematic risk management in this context and be able to draw on a well-balanced portfolio of financing tools to protect themselves, for example, from fluctuations in exchange rates and commodities prices. Has the dialog between banks and companies changed in recent years? Banks and their customers communicate very differently now. Communication has become more comprehensive and much more open. Today, every financing solution must be customized, not only because companies are positioned differently, but also because every industry has successful and less successful players. Consequently, banks spend much more time on understanding business models, analyzing risks and developing solutions. Companies, on the other hand, find it very important to understand how banks work and to inform them about developments promptly and openly.

DEUTSCHE BANK AG What are the main factors for success in managing crises over the long term? It is not really possible to give an across-the-board answer to this question because every case must be considered individually. But there are certainly some factors that are indispensable to sustainably managing every crisis. They include being absolutely open, accepting reality, making the most of the remaining assets and, above all, reacting quickly. The flexibility of the business model also makes a difference. Mr. Jezoreck, thank you very much for the interview. The interview was conducted by Lutz Jäde, partner and restructuring expert at Oliver Wyman.

Founded 1870 in Berlin, Deutsche Bank now operates in over 70 countries with employees from more than 135 nations. As a leading client-centric, global universal bank, Deutsche Bank is a reliable partner to its clients, providing ideally suited, customized financial solutions. For corporate and institutional clients, Deutsche Bank offers the entire range of services of an international investment bank – from transaction management to corporate finance, through debt and equity origination to advisory services in mergers and acquisitions. Furthermore, the bank plays a leading role in the international foreign exchange, bond and equity trading markets. www.db.com

PREPARING FOR THE NEW NORMAL Euro Crisis

After a slump in 2009, the machinery sector experienced rapid growth. Revenue quickly returned to pre-crisis level, and both profitability and equity base have recovered. On the whole, the industry has regained its health. But over the last nine months, the number of new orders has declined. As a result, 2012 will see little or no growth.

0.5% is the percentage decline of GDP forecast for the euro zone in 2012. For a long time now, economic forecasts have proven unreliable. Companies should prepare for different scenarios.

Publications by the banking group ING and the British weekly The Economist offer different scenarios for how the development of the euro will impact the machinery industry.

A strong euro A strong euro will put an end to the euro crisis. Trust in the financial markets will be restored. Interest rates in Southern Europe will decrease. This base scenario envisages very moderate growth of the global economy, and particularly of the euro zone. After declining by around 0.5 percent in 2012, GDP in the euro zone will increase by 0.1 percent in the coming years. In Germany, GDP will grow by as much as one percent, compared with 2.6 percent worldwide. Given this scenario, the volume of the machinery market could experience robust growth over the next years, on average in the mid-single-digit range. The industry is expected to resume its upward trend after a relatively stagnant 2012.

Greek exit from the euro zone If Greece exits the euro zone, the region would slip into a significant recession next year. Both ING and The Economist predict that GDP would drop by 1.5 to 2 percent if this scenario comes to pass. Germany too, would face stagnation – or even a slight recession – in 2013. A recession in Europe would also have an impact on the machinery industry. Its sales and revenues would probably fall by a double-digit percentage on average. Sub-sectors and companies with a high domestic and European share would be particularly hard hit. What’s more, it is likely that the euro would depreciate considerably. However, should this occur, European companies could expect greater profitability from their exports and to be more competitive than non-European rivals. Generally speaking, the industry would experience a significant recession, albeit not

Markets

as serious as the recession of 2008/2009. Should this scenario come true, companies would need to implement pre-defined emergency measures. The levers to mitigate the impact of such a downturn would be similar to those applied during the last crisis.

Collapse of the euro According to ING forecasts, if the euro collapses, GDP in Germany and Europe would decline by eight to nine percent in the first year, and by approximately four percent the next year. The whole of Europe, including Germany, would be hit by a deep recession. Because markets outside Europe would also be affected, ING predicts, the global economy would be plunged into a crisis much more disastrous than the recession in 2008/2009. A European recession would have serious consequences for the machinery industry – sales and revenue would probably plummet by more than 50 percent on average, and certainly decline more sharply than they did in 2008/2009. All sub-sectors would feel the affect. A collapse of the euro would considerably strengthen the new German mark. As a result, Germany as a production location would face similar problems to Switzerland when the Swiss franc appreciated in response to the financial crisis. Unit labor costs would skyrocket in Germany, and would more than offset the effects since the implementation of Agenda 2010. In general, machinery companies would relocate a large share of their sourcing and value creation to outside the German-mark zone. This would lead to massive job cuts among German machinery companies and suppliers. The bottom line is that the industry would have to deal with a much more threatening recession than in 2008/2009. What’s more, the next crisis would cause a structural shift in the value chain. This scenario calls for radical measures. In order to partially compensate for the exchange rate increase, companies would need to redesign the structure of the value chain, shift sourcing and value creation to areas outside the German-mark zone, and carry out currency-adjusted r eductions of personnel costs.

Uncertainty calls for flexibility Macroeconomic forecasts in recent years have been unreliable. Machinery companies would do well to brace themselves for more volatile markets. Strong and frequent fluctuations will be the new normal. Consequently, working-time models and cost structures must become much more flexible, and management tools must undergo further refinement. In view of today’s low-interest phase, it is no doubt a smart move to set up ample financing for the medium term, to help withstand crisis scenarios. In the past, the machinery industry has survived numerous crises, and has emerged stronger each time. This sector will make the necessary adjustments to succeed in the new normal.

Thomas.Kautzsch@oliverwyman.com +49 89 939 49 460

THE TIME HAS COME Connected Trucks

Competition is heating up in the connected trucks market. It has become a playground not only for OEMs but also for players from other industries. Although truck manufacturers will be able to maintain strategic control of this market with vehicle-related functions, they will only be successful if they open their platform to other providers. Telematics-based business designs and business processes will drive differentiation and unlock sources of profit. Currently, fewer than 1.5 million medium and heavy trucks globally are fitted with telematics solutions offering in-vehicle data connectivity. But by 2020, more than five million connected trucks are expected to be on the road. As a result, the market potential for innovative truck telematics solutions will grow from about 1.1 billion euros today to 4.5 billion euros.

CUTTING OPERATING COSTS

Connected trucks worldwide Installed base in millions; trucks >6t 5.1

+15% p. a.

1.4

2011

Markets

2020

The primary goal of truck customers is to reduce costs. Connected trucks are attractive to customers because they achieve savings ranging from 200 to 800 euros per month, depending on the particular system used. This means that a telematics system pays for itself in just a few months. Winning applications will process real-time information and be integrated into the vehicle. And “green” functions, aimed at reducing fuel consumption and carbon emissions, will become increasingly vital. Comprehensive real-time information about the traffic situation, free parking spaces, and ad-hoc load optimization enables logisticians to achieve both time and cost savings on a scale hitherto impossible. What’s more, thanks to real-time interactions between the truck driver, the vehicle, and the fleet manager, it is possible not only to incentivize the driver, but also to achieve fuel savings in the two-digit percentage range per truck. Today, every leading application focuses on the vehicle. Consequently, remote diagnostics functions that continuously monitor the condition of the vehicle’s auxiliary systems stand a very good chance of being successful. They give OEMs the opportunity to conduct remote diagnostics, suggest repair shops in the vicinity, and order spare parts before the vehicle actually

breaks down. Using remote diagnostics prolongs a truck’s service life and reduces maintenance costs by as much as five percent. Additional information about the condition of the vehicle’s load and about capacity utilization is equally important in order to optimize logistics.

A NEW GAME FOR OEMS Achieving success in telematics is no longer just an issue of technology. What is needed today are holistic, customer-oriented solutions with very short innovation cycles. That presents major challenges for OEMs. Manufacturers must not only acquire expertise in domains such as software development and application integration but in many cases must also build up capabilities for operating services across a connected truck’s entire life cycle. They must also be able to provide and sell telematics-based solutions. Numerous third-party providers of complete platforms, such as Masternaut and TomTom, are already established in the market. OEMs must therefore position their applications, platform strategy, and business design in ways that set them apart. The key to doing so is to attain a leadership position in the sector of vehicle-related applications, such as remote diagnostics. OEMs can exploit two advantages for this undertaking: their detailed understanding of the vehicle and their control of vehicle-related data flows. Nonetheless, it is essential for them to ensure that their system can accommodate innovative applications from third-party providers. Smart partnering with content or solution providers will help to supplement and round-off the overall offering.

out of 5 trucks sold worldwide will be fitted with a telematics solution by 2020.

DIFFERENTIATION THROUGH EFFECTIVE PROCESSES Effective business processes will make or break a manufacturer’s connectedtruck solutions. These processes generate value second only to applications themselves, and thus play a key role in differentiating an OEM from its competitors. Consider remote diagnostics, for example. Telematics-assisted end-to-end after-sales processes, which draw on repair-shop data and service agreements, are what improves repair-shop utilization and increases spare-parts profit and customer satisfaction. But telematics-based business processes and solutions also put organizations to the test. It is imperative that truck makers recognize that telematics are a driver in the shift from the product business of the past to the solutions business of today and tomorrow. Truck makers must redefine their organizational responsibilities, build new capabilities, and establish reasonable transfer pricing between the company’s business units. At the same time, they need to provide their sales team with appropriate training and define their valuecapture model in detail. The old model, based on one-time hardware costs and service subscriptions, has reached the end of the road. In the future, hardware will be reduced to the role of enabler. The time is right for innovative solutions. Truck makers must come to understand customer processes and segment-specific use cases. Formulating high-impact offerings now will help to differentiate themselves from rivals early on. If they fail to do so, then OEMs will see substantial revenue potential slip through their fingers.

Romed.Kelp@oliverwyman.com +49 89 939 49 485 Wolfgang.Krenz@oliverwyman.com +49 89 939 49 403

Grow or Go Wind Energy

In the coming years, the wind-turbine market will see only moderate growth. As a result, overcapacity and massive price pressure will trigger a wave of consolidation in this maturing industry. For manufacturers, size and growth are the order of the day, and M&A activity is imperative to increase market share. Those that cannot acquire competitors will need to find partners, or exit the industry.

83% decline in the average EBIT margin of non-Chinese wind OEMs in 2011 compared to its highest level in 2008.

The wind-power market stagnated in the wake of the financial crisis. From 2009 to 2011, new capacity increased, on average, by a mere 3.9 percent per year to reach 41.2 GW. Asia was the only region to experience strong growth in that period, with an average gain of 17.4 percent per year. In 2011, Chinese wind-turbine manufacturers ranked among the growth champions in terms of newly installed wind-power capacity. By contrast, a number of non-Chinese OEMs saw their newly installed capacity shrink. Internationally, manufacturers have to deal with overcapacity of 25 to 40 percent, which has led to slumping prices. Between 2009 and mid-2012, prices have fallen by about 25 percent. This trend has put an enormous strain on the profitability of wind-turbine manufacturers in the West. Whereas in 2010 they achieved EBIT margins of the order of 4.4 percent, this percentage dwindled to barely 1.4 percent in 2011. Some OEMs even saw their EBIT turn negative.

TREMENDOUS CHALLENGES Achieving substantial organic growth in the onshore segment will be difficult in the short term. Over the next three years, OEMs will have to adjust to continued low profit margins in their new business. This means they must focus on systematically managing costs and reducing product costs. At the same time, they cannot afford to neglect their service business, which particularly lends itself to growth initiatives. Indeed, many wind-turbine manufacturers have been more successful than expected in defending their market shares in the operations and maintenance sector. However, no one can yet say whether the growing number of long-term service agreements will be profitable in the long run.

Markets

Although the offshore market is experiencing high percentage growth rates, it accounts for just three percent of newly installed capacity today. In terms of absolute gigawatt figures, new onshore installations will continue to achieve higher growth and still make up more than 80 percent of the entire market in 2020. Furthermore, Chinese competitors are starting to venture outside their domestic market. Their entry into international markets with technologically comparable but lower priced products will generate even more competitive pressure.

WHY SIZE MATTERS To achieve success in this highly fragmented industry, companies will need to grow beyond a critical size. In the years to come, wind-turbine manufacturers will be forced to exploit cost advantages from economies of scale to an ever greater extent. As customers and operators of wind farms grow in size and become more professional, they will increasingly put their trust in large OEMs. Projects will become bigger and broader in scope, fueled by the growing offshore segment. As a result, customers will place higher demands on general contractors and complementary services, a development that could also be witnessed in the traditional construction of power plants. Financially strong players will be better equipped for this environment, not least by improving their risk management systems. Moreover, size and financial power make it easier to obtain project financing, and to make large-scale investments in R&D – a measure that is particularly crucial in the offshore segment, where Asian companies are currently undertaking major efforts to develop new wind turbines. Only size can ensure the necessary amortization of R&D investments.

Top-tier wind energy equipment OEMs New installations, CAGR 2008-2011 1

2011 including REpower Systems

Guodian

173% 105%

Mingyang Goldwind

46%

Sinovel

37%

Suzlon1 Siemens

20% 11%

Dongfang

Gamesa

Enercon

Vestas

-1%

Nordex

-3%

GE Energy

-3%

Acciona

-20%

If OEMs are to sustainably assert themselves in the global competitive arena, they must attain market shares considerably above 10 percent. Today, only industry leader Vestas has a larger market share – 12.7 percent – and that has shrunk substantially in recent years. The pressure on OEMs to achieve size will stoke the M&A market in the years to come. Large traditional powerplant manufacturers and engineering companies will increase their acquisition activities in the wind market and, in combination with their comprehensive service offerings, will win the race for the offshore segment, which is set to play an important role in the years to come – at least in Europe. At the same time, Chinese wind-turbine manufacturers will step up their endeavors to acquire non-Chinese competitors. As a result, Western players must act quickly to attain size if they are to be among the winners in 2020. Players lacking the resources to acquire companies should not strive to maintain their autonomy at any cost – doing so risks further erosion of their shareholder value. Rather, they should actively seek out a partner and operate in the market under its umbrella. In preparation, they must restructure themselves in order to be as attractive as possible to potential partners.

Wolfgang.Krenz@oliverwyman.com +49 89 939 49 403

THE END GAME IN PHOTOVOLTAICS The Solar Industry

Overcapacity and price erosion will further speed consolidation in the photovoltaic market. In the future, only a small number of companies with deep pockets will dominate the upstream business. That market is shifting toward the United States, the Middle East, and Asia. But downstream, the long-term outlook for German players is promising. In recent years, the solar industry has posted record growth, and the trend will continue in the years to come. A moderate scenario developed by the European Photovoltaic Industry Association (EPIA) forecasts that as much as 140 GWp of newly installed capacity will come on stream by 2016. To put that in perspective, just under 63 GWp of new capacity was installed in total in the last five years. At the same time, the markets are experiencing a shift from Europe toward the United States, the Middle East, and Asia. Europe was still the world’s largest sales market in 2011, with a 76 percent share of the global market; by 2016, however, that market is projected to drop to 30 percent.

CONSOLIDATION AND CHANGES IN THE SUPPLIER LANDSCAPE

Gross margins of cell and module manufacturers A s a percentage of revenue

2011 broke all records in the photovoltaic industry. The expansion of installed capacity surpassed expectations, particularly in Germany and Italy. This growth was driven by plummeting module prices and in Germany, a strong incentive to buy before the country’s subsidy policy could change. What’s more, the last few years have seen the installation of substantial capacity at all levels of the value chain. This development led to massive overcapacity, accompanied by high inventories, and thus contributed to a steep drop in prices. As a result, the gross margins of both German and Chinese suppliers hit a historic low in 2011. Today, low capacity utilization is forcing many companies to scale back production or close factories that are no longer competitive. Some suppliers were so hard hit that they had to file for insolvency; others had to give up their autonomy. This trend of consolidation or closure will persist.

60% 50% Top 3 40% Global average

30%

Asian players 20% 10% German players 2005 06

Markets

Today, only financially sound companies are able to invest heavily in R&D and set up sufficiently large capacities to realize economies of scale. This is particularly true in the upstream business. A number of global conglomerates with a solid financial base are planning to enter the photovoltaic market, or have already done so, and they are well positioned to dominate this sector

Growth of the global photovoltaic market Installed capacity in GWp Sources: EPIA May 2012, Oliver Wyman analysis

Moderate scenario: CAGR 6% p.a. over 2011 Aggressive scenario: CAGR 21% p.a. over 2011

77.3 62.1 52.2

40.2

41.4

29.7

2.5 2007

6.3

7.4

2008

2009

26.8 20.2

16.8

38.8

140 GWp

31.9

20.6

of capacity will be on stream worldwide by 2016, according to a moderate scenario. 2010

2011

2012e

2013e

2014e

2015e

2016e

in the long run. Consequently, German companies must carry out appropriate restructuring measures and implement cost reduction programs. Above all, they must identify those levels of the value chain where they can remain competitive for a long time to come, and rigorously revise their business design to capitalize on those areas. The solar market will remain attractive as a long-term growth segment – but the market conditions and the factors leading to success are changing. The solar industry is becoming just another “ordinary” industry.

FOCUS ON GROWTH MARKETS German companies will not run out of attractive business opportunities, even without the volume business of manufacturing cells and modules. They can continue their long record of success for many years to come by applying their traditional competencies both in niche markets and in their role as equipment and electronics manufacturers. Furthermore, the downstream business offers ample opportunities to serve novel market segments with innovative system solutions – and thus capture a higher value share. German companies focusing on downstream business enjoy an excellent reputation around the globe. Thanks to their impressive engineering expertise, they will be able to play a pivotal role in future growth geographies, provided they prepare for the regional market shifts early enough. Some growth markets, such as the United States, are marked by fierce competition – triggered by the entry of global module players into the downstream business. Other markets, such as the Middle East and Asia, still hold many opportunities. However, it is important to be aware that the customer structure in some geographies is heterogeneous, and that calls for specific market-entry and sales strategies. Companies also have the option to strengthen their own competitive position by entering into partnerships or carrying out targeted acquisitions in the still highly fragmented photovoltaic market. Such moves would not only improve a company’s purchasing conditions but also expand its sales channels. Generally speaking, there is much potential still to be tapped in the downstream business. But companies cannot afford to wait for long.

Wolfgang.Weger@oliverwyman.com +49 89 939 49 430 Andreas.Pradler@oliverwyman.com +49 89 939 49 436

SUCCEEDING THROUGH SUSTAINABILITY

Sustainability will be a driver of growth and value creation for a long time to come â&#x20AC;&#x201C; especially in the resource-intensive manufacturing industry. While sustainable products unlock new markets, they also call for sustainable production processes and systems. Companies that are quick to develop and implement structured programs for improving sustainability will be at an advantage and thus maintain and strengthen their competitiveness. Companies today face many challenges: volatile financial markets, Âthe Âincreasing scarcity and cost of resources, shifts in demographics, skills shortages, climate change, and economic and structural upheavals, to name a few. The pressure on them to act more sustainably is growing. Not only is there an urgency to use natural resources more responsibly, but customers are also increasingly demanding sustainable products. In addition, legislators are laying down stricter regulations. A white paper issued by the European Union, for instance, envisages all urban traffic being carbon neutral by 2030.

Commentary

Thus, sustainability is becoming a growing ecological, economic, and social necessity. Fundamental change on this scale brings with it new opportunities. And companies that capitalize on them will secure significant competitive advantages for themselves. In the manufacturing industry, as in other sectors, mere cost efficiency is no longer the main issue. Instead, the order of the day is to increase resource efficiency and develop new products. However, today’s production plants and processes are rarely optimized for resource efficiency. More often, they are designed for optimum throughput and cycle times. Innovative solutions and ideas are needed. Clean-tech technologies, for example, make it possible to use resources more efficiently, work at a lower cost, and cause less of an impact on the environment. Measures to improve the sustainability of e xisting production processes during the course of an investment cycle are also critical – installing components such as heat exchangers, for instance, or insulating ovens using state-of-the-art technology. Furthermore, sustainable product development also means taking a product’s life-cycle emissions into account.

NEED TO ACT QUICKLY Before executives can take action, they must first fully understand the implications of sustainability for their own company, and determine the opportunities it brings. Therein lies the problem. Market fluctuations, new structures, and persistent price pressure require immediate action by executives, and push sustainability off their radar screen. The fact that sustainability measures often constitute part of a solution to these problems is too frequently overlooked. Given these circumstances, the issue of sustainability has been slow to gain a foothold in plants and on shop floors and with suppliers and product designers. Structured approaches and systematic concepts that combine competitive advantages and ecologically sound business operations are still rare. But only companies that read the signs of the times correctly and act quickly will be among the winners. The food retailer Coop, which operates one of the largest bread bakeries in Switzerland, is setting an example of how to do this. Coop has a clear goal: to achieve wholly carbon-neutral business operations and production by 2023. At the same time, the company intends to reduce its total energy consumption by 20 percent.

SEIZING OPPORTUNITIES Time is running out. Companies that fail to move quickly will fall behind. It is essential that enterprises identify the right set of strategic measures and increase their employees’ environmental awareness. The emerging opportunities are immense. Sustainable companies offer more attractive jobs and, in contrast to their rivals, will be less affected by the shortage of skills. Above all, sustainable companies will give themselves a competitive edge for the next five to ten years.

Michael.Lierow@oliverwyman.com +49 89 939 49 757

TACKLING TOMORROW’S CHALLENGES Research & Development

72 percent of senior executives consider innovation to be a top-three strategic priority, but fully 42 percent are not satisfied with their company’s ability to innovate, according to a recent Businessweek survey. Everybody strives to innovate, but only few truly succeed.

72% of senior executives consider innovation to be a top-three strategic priority, according to a Businessweek survey. But 42% are not satisfied with their innovation system.

Industrial companies face many challenges in the areas of innovation and product development. On the product side, saturated markets, the accelerated pace of change, and the rising importance of emerging markets are forcing companies to develop more sophisticated, differentiated, and often localized products more quickly and in greater numbers than ever before. On the cost side, pressure to tighten budgets has become the norm, and the task of developers has thus become critical. On the efficiency side, since many corporations have spread their R&D operations across the globe, coordination becomes more difficult, but not less essential. As a result, R&D organizations are finding it more and more difficult to strike a balance between the conflicting priorities of increasing output, reducing costs, and managing growing complexity.

NEXT GENERATION R&D A revolution is needed if companies want to set up a next-generation R&D system with the following key characteristics: Open innovation: from NIH (Not Invented Here) to PFE (Proudly Found Elsewhere). Internal teams cannot be expected to have all the knowledge necessary for successful innovations. It is important to capture new ideas from universities, customers, and start-ups by drawing on external sources, enlisting scouts, entering into partnerships, and the like. Successful open innovative companies like IBM have developed dozens of new products with extensive outside input. Selective development: from a wide to a deep portfolio. Researchers’ curiosity, passion, and strong belief in success have significantly increased the number of R&D projects in a company’s portfolio. To achieve the expected results and avoid scattering resources, innovation executives must efficiently manage the risk/reward balance of these portfolios.

Operations

Transparency on R&D performance: from R&D intensity to R&D efficiency. Measuring R&D is a complex but essential undertaking. Best-in-class R&D organizations have already designed customized KPIs to measure the performance of their “R&D factory” and benchmark it against competitors. Results sometimes shake established beliefs, but they can trigger a burst of awareness and lead to a virtuous improvement cycle. Agile and frugal: design as if it was your own money. Some once- successful R&D giants have become too complex to succeed in the current environment. Our turbulent times require fast response times and frugal development methods – skills that many behemoths lack. Redesigning from the grey sheet rather than from the blank sheet must become the norm. Companies will increasingly outsource some development work to agile and cheaper start-ups and growing internal start-ups in the coming years. Globally connected: from a centralized footprint to a global network. R&D projects are often spread over multiple sites and therefore face numerous barriers (such as different cultures, time zones, and IT tools). To distribute work efficiently and coordinate resources, the use of the same platforms and effective cross-organizational exchange networks are critical, as are reliable communications. These are arguably among the biggest challenges faced by many R&D organizations.

Impact of RIDE projects

60% 50%

30% 30% 25% 11%

14%

2% Quality improvement (non-quality costs, ppm)

Time-tomarket reduction (months/ weeks)

R&D cost reduction (resources, prototypes, Capex)

Product cost reduction (unit cost, TCO)

Collaborative organization and governance: breaking the silos. In our experience, complexity of the R&D organization is often the major cause of disturbances on projects. For R&D organizations to become agile again, they need to create greater simplicity and empower their people. This is becoming more and more challenging as the growing use of software and automation technologies introduces even more layers of complexity. Virtual development: simulation as the backbone of the development process. IT simulation tools have an immense and untapped potential for accelerating new project developments.

OLIVER WYMAN’S RIDE PLATFORM Oliver Wyman uses its proprietary and comprehensive RIDE platform (Research Innovation & Development Excellence) to help clients transform their R&D organizations to reach a higher level of sophistication and performance. A broad set of proven tools and methodologies is applied to assess the maturity of an R&D organization and to identify the main levers for change. Often, the scale of change is such that it is necessary to proceed step by step, gather wide support, and eliminate risks of distraction and scattering of resources. Changes must not only be defined theoretically, but they must also be tested on pilot projects and then be deployed globally. As with all major transformation projects, success comes with clear targets, ambitious deadlines, unwavering support of general management, and strong mobilization at all levels. The results speak for themselves.

Wolfgang.Krenz@oliverwyman.com +49 89 939 49 403 Marc.Boilard@oliverwyman.com +33 1 45 02 32 19

STRATEGICALLY OPTIMIZING INDIRECT PROCESSES Production

Industrial companies are under pressure to improve their cost position. This especially applies to material and direct production costs. More often than not, however, indirect production-related processes are disregarded, or outsourced – despite their enormous cost-saving potential. Projects aimed at holistically improving the efficiency of quality, maintenance, and logistics produce savings between 15 and 25 percent – and they effectively support those areas generating direct value added. Systematically optimizing indirect processes would give rise to additional measures for safeguarding production locations in Europe. Global competition and the economic downturn are forcing industrial companies to further reduce costs. Most target material and manufacturing costs – by executing company-wide sourcing and product-cost projects, for instance, to cut the costs of material, and by applying lean production methods to optimize manufacturing processes and eliminate unnecessary costs. HPV development in automotive production In hours per vehicle (body, paint, assembly) -5 % 39.0 Support

3.31

3.55

Indirect 8.66 processes

11.15

Manu27.06 facturing

22.54

Ø 2007

37.2

Operations

Ø 2011

However, holistic optimization programs only rarely focus on indirect production-related processes such as maintenance, quality, and logistics. There are many reasons for this. For one thing, it is difficult to measure process performance. For another, it’s hard to make the resources deployed and cost drivers transparent. In many instances, companies either define a uniform cost target for their internal processes or outsource them entirely. As a result, they forego substantial cost savings.

A holistic approach To achieve the best possible transparency and comparability, a company must first comprehensively document all of the resources involved in each process using a standardized method. Resources include the company’s 39,0 37,2 employees as well as its material and overhead costs. It is important to do 3,31 3,55 this for both direct and indirect processes. Reference process models, which are available for each industry sector, 8,66 are suitable tools for this 11,15 work. With their help, it is possible to unambiguously allocate resources to specific

27,06

22,54

rocesses, develop preliminary benchmarks, and identify primary p optimization levers. Next, a company must make a strategic decision about which indirect production-related processes should be carried out internally to reinforce value-adding processes, and benefit from economic advantages. Once a company has defined its core products and processes, it must specify its coverage of the value chain, and choose its make-or-buy strategy. The actual realignment of indirect processes occurs during the so-called process-design phase. Employees and experts affected by a process change should be closely involved in this stage. It is essential to lay down clear process-design rules in advance which can then be used during the project to clearly evaluate process options. In addition, cross-departmental teams must be set up and workshops carried out to identify current process deficiencies and to develop possible solutions with the help of reference and standard processes. To conclude the project, a preliminary assessment of the effects on savings and efficiency, as well as implementation time and costs, should be performed. Consulting a standard process library can save teams a lot of time, as they can use best practices from their own and other industries as guidelines and possible approaches to process optimization.

HPV development in indirect production-related processes +28 % 11.15 8.66 Logistics

3.37

Quality

3.28

Maintenance

2.01 Ø 2007

4.64

4.20

2.31 Ø 2011

Before the revised processes can be put in place, organizational structures need to be adapted to fully support them. Both the organizational and the leadership structure must be modified to accommodate the new indirect processes which, inevitably, also affect direct processes. Companies with multiple locations have the opportunity to optimize their indirect processes in such a way that they are comparable across sites. This standardization is very important for ongoing performance measurement.

Factors determining implementation success Optimization projects bring change, of course, and that can inspire fear in the people who will be affected by these changes. Clearly and transparently communicating the project’s goal and the change process will help to mitigate those fears. In addition, top management must be regularly updated on the project’s progress. Large industrial companies are well-advised to involve their social partners very early on. Holistically optimizing indirect production functions is also an effective way to improve a company’s competitiveness. It enhances support for and the performance of direct processes, and increases economic efficiency. Our project experience has shown that cost savings between 15 and 25 percent can be achieved in indirect production-related processes – while at the same time improving production efficiency. If this potential is systematically unlocked, Europe will be one step closer to safeguarding its production locations.

Andreas.Moritz@oliverwyman.com +49 211 898 76 88 Christian.Heiss@oliverwyman.com +49 89 939 49 588

Manufacturers have a huge opportunity to improve their financials by managing the risks inherent in their capital investment projects better. Below is an excerpt from an article in The Oliver Wyman Risk Journal which describes our firm’s approach to managing the risks involved in building power plants, factories, transportation infrastructure, and other large investments. This unique approach has helped our clients to reduce their cost overruns and delays on such projects by 20 percent or more.

MAXIMIZING RETURNS ON LARGE INVESTMENT PROJECTS At any given moment, more than 200 large public and private capital investment projects, each worth at least USD 500 million, are in progress globally. Thousands more valued at USD 100 million are under way. These gargantuan numbers are bound to become even bigger. An estimated USD 53 trillion needs to be invested in public infrastructure by 2030 to keep the global economy on a firm path t o recovery, according to a recent study by the OECD supported by Oliver Wyman’s Global Risk Center. Unfortunately, unless organizations improve how they manage the risks inherent in large projects, these investments could suffer from huge losses. Consider: The construction of a nuclear power plant typically runs over budget and is 150 percent behind schedule. In addition, utility companies forego roughly USD 1 million in revenues every day that a plant’s construction is delayed. Indeed, the real cost of a delayed construction project can be more than five times the cost estimated during the development phase.

Alexander.Franke@oliverwyman.com +41 44 553 3511 Kristina.Gerteiser@oliverwyman.com +49 89 939 49 432

Publications

Oliver Wyman’s project experience has shown that companies can often reduce cost overruns and delays by at least 20 percent by professionally managing the risk of large infrastructure projects. At every stage of a project’s life cycle, organizations can improve their large projects’ returns significantly by making risks transparent, and subsequently quantifying and anticipating them. At the same time, companies must flexibly adapt both the focus and plans for their project to changing conditions and difficulties as they arise. In addition, they need to establish key milestones that can be tracked to avoid potential problems before they negatively impact a project’s results.

STAGE I: INVESTMENT DECISION By identifying the risks inherent in different options, companies can quantify and take into account how their fundamental project decisions will impact a project’s future returns – even before deciding to invest in a specific project. They can prioritize competing projects and thus build a project portfolio with higher risk-adjusted returns. By including operational, technical, and economic information in their risk assessment, railway companies, for example, can choose the capacity-expansion option which yields the most stable returns in different economic scenarios.

STAGE II: PROJECT PLANNING Companies need to design a project plan so that it will have the most flexibility after examining different trade-offs. Sometimes achieving the highest riskadjusted return means acquiring extra materials and additional staff. For example, a company may buy two sets of a key piece of equipment and then save one in case something goes wrong. Such deliberate redundancies help mechanical engineering companies and suppliers to avoid costly delays when it becomes necessary for them to increase their capacities.

STAGE III: PROJECT EXECUTION Another key to improving a large project’s returns is for managers to monitor its operational and financial performance closely. Operational key performance indicators, such as accident frequency and maintenance quality, as well as future-oriented cost/benefit analyses of countermeasures can help to improve both the stability and the quality of the process. By setting up an early warning system, a leading European utility company, for example, was able to avoid delays during the construction of a power plant and saved several hundred million euros as a result. In our experience, companies that apply state-of-the-art risk management techniques to their large projects can significantly reduce delays and cost overruns. World-class businesses are increasingly tapping this potential.

THE OLIVER WYMAN RISK JOURNAL The Oliver Wyman Risk Journal is a collection of perspectives on the complex risks that are determining many companies’ futures. It provides insights on how companies can improve their performance by managing risks more effectively. The Risk Journal highlights how emerging risks are developing into pressing threats. It also explores the urgent need for companies to develop more risk-aware cultures. Other perspectives examine how enterprises can better meet new challenges introduced by developments such as rising sovereign risk and increasing scarcity of financial resources. An online version is available at www.oliverwyman.com/riskjournal.

ABOUT OLIVER WYMAN Oliver Wyman is a global leader in management consulting. With offices in 50+ cities across 25 countries, Oliver Wyman combines deep industry knowledge with specialized expertise in strategy, operations, risk management, organizational transformation, and leadership development. The firm’s 3,000 professionals help clients optimize their business, improve their operations and risk profile, and accelerate their organizational performance to seize the most attractive opportunities. Oliver Wyman is a wholly owned subsidiary of Marsh & McLennan Companies [NYSE: MMC]. For more information, visit www.oliverwyman.com. Follow Oliver Wyman on Twitter @OliverWyman.

Manufacturing Industries Oliver Wyman’s Manufacturing Industries practice supports manufacturing companies in restructuring and realizing profitable growth. The practice combines deep industry expertise with specialized skills. Based on that experience and knowledge, we publish industry-specific studies and benchmarking data bases that are available to our clients. Our goal is to rapidly make a real business impact for industrial enterprises around the world. please contact industries@oliverwyman.com +49 89 939 49 424 +49 89 939 49 501 © 2012 Oliver Wyman. All rights reserved.

publisher’s information Editors: Kristina.Broeckling@oliverwyman.com, Andrea.Steverding@oliverwyman.com Responsible: Thomas.Kautzsch@oliverwyman.com Design: Vogt, Sedlmeir, Reise. GmbH, Munich

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