The growth dilemma
How engineered component manufacturers
build a second act
By Jamie Bader, Managing Director
Parthenon-EY Diversified Industrial Products practice
The growth dilemma: How engineered component manufacturers build a second act
The growth dilemma:
How engineered component manufacturers build a second act
Sustained top-line growth is one of the clearest avenues to driving shareholder
value. After years of creating value through cost efficiencies, growth has once
again become a focus for business leaders and investors. At Parthenon-EY,
we regularly work with industrial companies and their investors to identify growth
opportunities. In our experience, there is one group of companies whose
characteristics pose unique challenges to maintaining long-term growth. We
define these companies as “engineered component manufacturers.” We are
interested in these companies due to the place they occupy in the value chain
and their growth characteristics. Our research indicates that many of these
companies deliver above-average profitable growth for a time. However, they
invariably reach a point where it is difficult for them to sustain their momentum
and build a second act. We call this “the growth dilemma.”
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Parthenon-EY Diversified Industrial Products practice
A virtuous niche
Engineered component manufacturers are
2
companies that sell highly technical components
This is a technical sale, and OEMs often choose
to original equipment manufacturers (OEMs).
to single-source these products. Many even design
They occupy a “virtuous niche” in the product
their products around the component capability.
value chain, which allows them to achieve
This significantly raises customer switching costs,
above-market growth and profitability. These
reducing customer churn.
companies’ products share three distinct features:
1
The components are often “spec’d in” by OEMs.
3
The components are highly technical and
The components are mission-critical and have a
high cost of failure relative to their cost. The end
value-added. These companies develop
user will experience costly repairs or downtime if
components that outperform existing market
the component fails. Because these components
solutions, sometimes significantly so. In
are mission-critical and are usually low-cost
addition, the components require unique
relative to the cost of failure, OEMs are willing
technical knowledge and are sometimes
to pay a high price premium.
patent-protected, making them difficult
to recreate. This creates high barriers to
We have seen engineered component manufacturers
entry, making them less susceptible to
carve out this virtuous niche in many different
competition. The result is rapid adoption
industries, such as consumer electronics, photonics,
and high penetration rates, leading to
test and measurement, fluid handling and power
above-market growth rates and high margins.
transmission. Table 1 summarizes the characteristics
that lead to high growth and margins for engineered
Table 1: Illustrative value chain
Characteristics
Company size
Raw
Materials
Components/Subsystems
Engineered
Commodity
OEMs/
SIs
Very large
Mid-size
Varied
Large
Engineering Value Add
Low
Very high
Low
Varied
Customer Switching Cost
Low
Very high
Low
Varied
Competitive Environment
High
Low
High
Varied
Varied
High
Low
Varied
Low
High
Low
Varied
Relative Market Share
Operating Margin
End
customers
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The growth dilemma: How engineered component manufacturers build a second act
components and contrasts them with characteristics
of players in other places in the value chain:
Figure 1: Component company performance vs. OEMs, growth, profitability,
2004–2014
30%
• Raw material suppliers generally provide commodity
products and compete on scale. Competition is fierce
is dependent on end-user demand and margins are
low. Examples include steel and plastics providers.
• OEMs may have more attractive competitive
dynamics, but often are no more than component/
subsystem integrators. As such, their engineering
value-add can be low and differentiation may be
difficult. Growth is limited by end-market demand
6 year revenue CAGR (2007–2013)
and share gain opportunities are limited. Their growth
20
Component
company
10
OEM
0
and margins are suppressed. The personal computer
$1,500M
industry is the classic example.
• Commodity component companies also generally
depend on scale and are often dual-sourced by
-10
0
10
20
30
40%
10 year average EBITDA margin
OEMs; competition is high and margins are low.
This is true of electronic components, such as
printed circuit boards, and certain automobile
parts, such as radiators.
Figure 2: Component company vs. OEMs indexed growth, 2004–2014
5
Consider the metal cutting laser industry as an
example. Laser manufacturing requires many
Component
OEM
4
commodity components, such as electronic
componentry, where growth and margins are low.
OEMs in this industry add considerable expertise and
3
value, but they are only able to grow as fast as their
customers’ demand for metal cutting applications.
Competition in relatively undifferentiated products
2
can lead to margin pressure.
1
The highly engineered optical components company we
highlight in Figures 1 and 2, however, has significantly
outperformed its OEM peers over an extended period
of time. Its technical expertise allowed it to grow rapidly
as it penetrated the laser OEM customer base while
maintaining high operating margins.
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Parthenon-EY Diversified Industrial Products practice
0
2004
2006
2008
Years
2010
2012
2014
Traditional growth options may not be available
The same dynamics that make these companies
so attractive will eventually cause their growth to
Figure 4: Component manufacturer segment revenue growth during high and
low growth periods
stagnate. Once the companies achieve high penetration,
it becomes difficult to grow above the market rate.
13%
First
11 years
When the OEMs have adopted the technology, the
High growth
component manufacturers’ growth will track
Low growth
the growth of those OEMs, mirroring end-user
First
14 years
10
demand growth.
All of the business units shown in Figures 3 and 4 saw
rapid market adoption between years ~4 and ~10,
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but struggled with growth once their market share
Last
3 years
reached a certain level. This is the growth dilemma for
engineered component manufacturers: how can these
First
10 years
Last
4 years
5
companies continue to achieve above-market growth
once their products have seen widespread adoption?
3
Figure 3: Component manufacturer segment or application revenue over time
$400M
Last
4 years
0
Highly Engineered
Bearings
Material
Processing Laser
Components
Medical Imaging
Components
300
A compounding factor is that many of the standard
growth options are unavailable to engineered component
200
manufacturers, as illustrated in Table 2 (see next page).
Market share and share of wallet are not options once
high penetration has been attained. Both forward
100
and backward integration require entering completely
different businesses, and are therefore not reasonable
options. And acquisition/consolidation is rarely available,
0
1
2
3
4
5
6
7
8
9 10 11 12 13 14 15 16 17
Years
Theoretical
Company segment medical imaging components
Company segment highly engineered bearings
Company segment material processing laser components
due to the unique technology content and high market
share. In fact, once high market share is attained, the
company’s position is so favorable that other acquisitions
can seem unattractive.
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The growth dilemma: How engineered component manufacturers build a second act
Table 2: Traditional growth options
Growth Option
Rationale
Market Share
Converting ‘greenfield’ or
competitor customers enables
existing product growth
• Design-in cycles are long, and if not designed-in,
suppliers cannot displace competitors
Share of Wallet
Strengthens customer relationships
and increases supplier power
• Successful component manufacturers are typically the
primary/sole source of the component for the OEMs
and already have a very high share of wallet
Forward Integration
Selling complete systems or
subsystems allows manufacturers
to capture OEM margin
• A typical OEM is a large company with system
integration capabilities
Integrating into raw material gives
manufacturers complete control
over sourcing
• Raw material markets tend to be commodity markets
with heavy competition and scale requirements
Concentrates supplier power with
manufacturer and often confers
pricing power
• With an already high market share, acquiring a
competitor if available is less likely to have an impact
on enhancing overall market presence
Backward Integration
Acquire Competitors
Difficulty for Component Manufacturers
• Successful component manufacturers often already
have high share
• Component manufacturers would typically not have
the size or capability to forward integrate
• Anti-trust issues may arise given high share
Building a second act
We have identified potential growth options that may
However, penetration often requires application
be suited to component manufacturers, each with its
knowledge that may not exist within the company.
own set of unique challenges:
• Subsystems Opportunities
• De-feature technology
If subsystems exist that are dependent on the
De-featuring a technology or providing lower
component for performance, often times the
performing components can open up new,
component manufacturer can “move up the value
sometimes larger, customer opportunities.
chain” to become a subsystem provider. However,
However, engineers accustomed to designing
subsystem opportunities don’t always exist. If they
highly engineered products very often have
do, it may require competing with current
difficulty designing a cost-competitive,
customers, an often difficult transition to manage.
defeatured product.
We have seen companies attempt to pursue these
• Repositioning technology
options, only to fail because they did not fully under-
Repositioning the technology for new applications
stand the challenges. Each option requires in-depth
opens up new markets/customers and can reignite
research and careful analysis to decide whether or
high growth through new market penetration.
not it can and should be employed to drive profitable,
above-market growth.
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Parthenon-EY Diversified Industrial Products practice
The Parthenon-EY approach
Parthenon-EY has developed an opportunity identifica-
built around frameworks that allow an organization
tion process that helps business leaders of component
to refresh its strategy over time.
manufacturing companies efficiently identify, prioritize
Through the process of identifying potential growth
and act on available opportunities.
strategies, assessing the operating requirements
The approach is fact-based and rigorous and
of each, quantifying the likely impact of each and
relies heavily on a deep understanding of the
developing an action plan to take advantage of the
precise market in which companies operate. It is
most promising, component manufacturers can
collaborative, incorporating input from all levels of
build a second act for their companies out of a
the organization, and is repeatable and systematic,
single product line.
Parthenon-EY’s opportunity identification strategy
Potential
growth
opportunities
Deliverables
Assess
potential
opportunities
• Develop a proprietary
opportunity assessment
score card
• Construct a detailed fact
base through primary
and secondary research
Conduct
deep dives on
prioritized
opportunities
• Create a detailed fact
base for the prioritized
opportunities
Develop
action plan
Strategy
road map
• Generate a list of
prioritized opportunities
with an action plan
• Conduct detailed primary
research on opportunity
• Assess the likely potential
under each opportunity and
related investments, risks and timing
Approach conclusion
In an environment where it is increasingly difficult to drive above-market growth, engineered component manufacturers
are able to deliver consistently. However, the characteristics that make these companies so attractive also can cause
growth challenges long term. Only through a systematic and in-depth evaluation of market dynamics and internal
capabilities can business leaders choose the growth strategy that will deliver maximum value to the organization. By
following this approach, investors and business leaders can extend a component manufacturer’s above-market growth
indefinitely and overcome the growth dilemma.
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Author
Jamie Bader
Managing Director
+1 617 478 4621
Contributors
Max Pinto
Senior
Consultant
Jeff Bates
Consultant
Becca McGovern
Associate
[email protected]
For more information on our Diversified Industrial Products practice and our team, please go to www.parthenon.ey.com
About Parthenon-EY
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About Parthenon-EY Diversified Industrial Products practice
Parthenon-EY’s Diversified Industrial Products practice advises a broad range of products and services companies across
every major industrial sector. We deploy tested analytic tools and draw upon a deep bench of experienced professionals to help
mid-market industrial companies achieve above-market growth and operational improvements. Our experience has allowed us to
address an array of business challenges, including market entry strategies, commercial due diligence, value-chain positioning and
pricing strategies, competitive assessments, and cost optimization for clients throughout North America, Asia, and Europe.
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