Consolidation in changing markets
The price war in the power generation equipment business means that for many equipment manufacturers, switchgear sales are forming an increasingly vital role in their financial performance. Margins from medium and high voltage electrical equipment sales are expected to continue to outperform those in the power generation industry for some years to come, even in parts of Asia.
MarketLine International, London, United Kingdom
Size has been the byword for switchgear manufacturers throughout the 1990s, with market leaders responding to changing market conditions by simply getting bigger.
The rapid electrification in Asia has been the main focus of expansion for global competitors, although there are a large number of local manufacturers successfully holding onto their market share. This will prove more difficult with time, and with the current economic climate in Southeast Asia, acquisitions or joint ventures are sure to account for many independent manufacturers.
The giants of the switchgear industry, ABB, Alstom and Siemens have much of their businesses wrapped up in power generation and transmission and distribution (T&D) equipment, although T&D equipment is often given a back seat.
Switchgear sales, however, are forming an increasingly vital role in their financial performance through balanced revenue streams and higher margins. Switchgear has remained insulated from the cut-throat world that is the power generation equipment business, and its major suppliers will be keen to keep it this way.
Changes in the customer base, particularly through privatization and electricity market liberalization, have been the major driving force behind the current price war in the power generation equipment business. This, and manufacturing overcapacity, has forced manufacturers to drop their prices to barely sustainable levels in order to fill their order books. Yet in the switchgear markets this has not happened, and although some price pressure is evident, similar developments are not expected.
In the electricity transmission business, competition barely exists – and nor is it likely to start – due to the obvious preference for one electric network. In the electricity distribution market the situation is different as electricity supply liberalization sweeps the globe.
This will certainly make electricity distribution companies more cost sensitive, but the advantages of low cost switchgear in a competitive distribution market are rather less than the advantages of low cost generation equipment in a generating market. Low cost generating equipment gives competitive advantage to its owner, whereas low cost switchgear simply saves its owner money. Although cost savings is a powerful argument for expecting price cuts, the same can be said of any industry. For this reason it can be expected that T&D margins will continue to outperform those in the power generation equipment industry for some years to come.
The world switchgear market is dominated by three major regions, with the rest of the world contributing only 12 per cent of the total market value. Asia, Western Europe and North America are all of approximately equal size, although the current financial problems in some Asian countries has dragged its share down. Asia presents a very different market to the mature markets of Europe and North America, which offer mainly replacement, upgrade and industrial switchgear markets, rather than electric grid expansion projects.
Asia became the biggest power engineering market through a combination of its high economic growth and under-developed infrastructure. Rapid GDP growth fed rising demand which was not adequately supplied by the region`s electricity networks.
The Asian crisis has changed this situation by cutting back the rise in demand and reducing the funds available for investment. However, the effect on the various Asian countries has been very different.
Japan is the region`s economic powerhouse. However, its economic maturity limits its need for new infrastructure spending. At present, the Japanese economy is falling into recession. The main area of interest in this is the consumer sector which the government is trying to revive. Switchgear investment is tertiary to the main problems of the economy.
The other big economies in the region are China and India. Both are relatively insulated from the region`s crisis. Both China and India are still not fully liberated from their older traditions of autocracy. This has limited their exposure to the international crisis. Moreover the switchgear market in both is relatively stable as they regard electricity infrastructure as paramount.
Indeed, India has still not solved its old problem of demand outrunning the capacity for expansion. The problem in India has been compounded by the regulatory framework. The state electricity boards (SEBs), traditionally the main customers of switchgear manufacturers, have weak finances. The principal reason for this is the government`s restriction upon electricity prices.
The policy limits the capital that the SEBs have from their own operations or that they can raise from outside lenders to invest in their transmission and distribution networks.
China is likewise expected to see a more moderate investment in infrastructure for the next five years. The Beijing government has devoted considerable resources to linking the country`s regional networks. Lower economic growth is likely to reduce the resources available for such improvements. Nonetheless, the switchgear market should avoid a crash of the kind found in Southeast Asia and other areas hard hit by the crisis.
Malaysia, Indonesia and Thailand have all been hard hit by the economic crisis. Malaysia is seeking a return to greater national control. Many power projects have recently been cancelled due to lack of funds. The consequence is that the value of the switchgear market has plummeted. This has also been the case in Thailand, but the government has taken a contrary approach.
The Thai government accepted an IMF deal which demands certain austerity measures in return for help. Although Thailand has also seen its switchgear sales collapse, it is predicted to make a faster recovery. Indonesia, the biggest of the three switchgear markets, has seen sales fall just as dramatically. It is also even more affected by the sharp increase in the price of imports than the other two. This is a consequence of the devaluations which increase the cost of the switchgear to the manufacturer, without the money feeding through to the supplier.
North America is the third largest market in the world. The region has a relatively good growth rate in terms of switchgear market value. Most of this is driven by North America, where the economy is still prosperous. However, the Brazilian market is currently seeing its utilities undergo privatization. This should make its markets more open to foreign investment, and hence cause the value of the switchgear market to grow. The main threat to this is caused by the general nervousness about emerging markets following the collapse of several Asian economies and the recent disintegration of Russia`s financial system.
Western Europe is a much more stable market than Asia. There are four major economies in the region: Germany, France, Italy and the UK. All of these are mature economies with well developed electricity infrastructures. For this reason, the European markets are far less superficially dramatic, although they have interesting features of their own.
The competitive structure of the European market is well developed, with the principal international switchgear manufacturers firmly entrenched as suppliers. The main exception to this rule is the UK where the leading supplier is FKI, through its Hawker Siddeley brand.
The market players
Alstom has just undergone the most dramatic change of any of the big power engineering companies. Formerly the Anglo-French joint venture GEC Alsthom, the revamped company has been floated on the Paris stock exchange. Alcatel and GEC sold 52 per cent of their holding in the first half of 1998, and the rest will not be sold before 1999. The move allows GEC to leave the power engineering sector, where it does not have long term strategic interest, in order to concentrate on its defence industry core.
The flotation is the latest of Alstom`s attempts to adjust to changing markets. By losing its joint venture status it can hope to gain greater flexibility in the face of market changes.
Another interesting element is Alstom`s effort at increasing its mass to the critical level. In 1996 it acquired AEG`s T&D division from Daimler Benz. Daimler Benz took the strategic decision to dispose of its AEG operations as it felt that it would not be wise to devote the strategic resources which the area would demand. Alstom acquired it for the contrary reason that it was devoted to the area as a core competence. Strategically, the acquisition has the advantage of helping Alstom penetrate markets such as Germany and Scandinavia, where it has historically been relatively weak.
In February 1998, the company announced a more minor acquisition – the Marconi Automazione group in Italy. This was bought from GEC Marconi in Italy. The two companies included in this deal are Marconi Automazione SpA and FIR SpA. Together, the two subsidiaries had a turnover of about Ecu60 million ($70m) in 1997 and 630 employees based at manufacturing facilities in Monza and Peschiera, near Milan, and at San Pellegrino Terme, near Bergamo. Their products are largely utilized in electrical distribution networks and include instrument transformers, disconnect switches and protection relays. This adds to the Alstom facility near Venice which manufactures disconnect switches and switchgear.
Swiss-Swedish engineering group ABB initiated the industry`s move towards a new scale of critical mass when its founder companies, Asea and Brown Boveri, merged in 1987. In 1998, it is the biggest transmission and distribution equipment manufacturer in the world. Its size is an important part of its success since it allows the company to bundle its various products together. It is one of the few companies in the world with the capability to manage highly complex generation and transmission projects.
Under Percy Barnevik, the company embarked on a programme of globalization. The strategy was founded on a number of beliefs. An important factor was moving production as close as possible to the customer. The idea was to make the company more responsive to customer needs. A second factor was ABB`s awareness of costs. ABB has a corporate record of strong emphasis on raising margins as much as possible. The shift of production to emerging markets is therefore also intended to reduce expenses through lower labour costs.
Although ABB has been at the cutting edge of developments over the past decade, its very modernity has ironically disadvantaged it in the new climate. By exposing itself so much to Asia, ABB has put itself in the firing line of the economic crisis. Its massive contract to supply equipment for Malaysia`s Bakun hydropower project has been suspended along with several other contracts.
In the long term, Rolls Royce is threatened by the need to develop critical mass in both power engineering and aerospace. For this reason, Rolls Royce T&D was touted as a possible target for other firms. This suspicion was confirmed late in September when Rolls Royce announced the sale of its T&D business to VA Tech Elin for £137.5 million ($255m).
The possibility of take-over was perhaps one reason that Rolls Royce was trying to bundle its highly successful brands, such as Peebles and Reyrolle, more efficiently.
Siemens was traditionally a national champion, but for some years it has been trying to internationalise itself in a belated effort to catch up with industry trends. A key element in this is the production base. According to Siemens, whilst two thirds of their value added production is located in Germany; two thirds of the customer base is outside Germany. introduction of the single European currency will make it easier for Siemens to concentrate production at particular sites. In effect the abolition of exchange barriers will make the single currency area resemble a single domestic market to a greater extent than it currently is. Siemens has also been trying to increase productivity within Germany. The payroll throughout the company has fallen during this decade. However, the size of the fall is much bigger in Germany than in the company world wide.
Siemens is reviewing its strategy to focus on core areas. To improve performance, the Siemens management may consider stripping out non-core activity in the same way that Daimler-Benz has done. The sale of the defence business may be an harbinger of this strategy.
If Siemens does decide to adopt such a strategy, it is likely to stay in power engineering. As with ABB, it will need to maintain its capacity with T&D as part of an overall package, and to offset the poor margins available to its power generation equipment unit.
MarketLine International is a global research and analysis company specialising in the power equipment and energy industries. MarketLine publishes a wide variety of market information reports on the power generation, transmission & distribution equipment industries based upon primary research and significant expertise in the area. MarketLine can also offer tailored research and analysis services.
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?Figure 1. World switchgear markets by region, 1998
Figure 2. Electricity distribution companies will become more cost sensitive
Figure 2. Market value for total high voltage and medium voltage switchgear market in Brazil, 1995-1998
Figure 3. European high and medium voltage switchgear suppliers by country, 1998