Indian tigers, Chinese dragons: driving global CE industry

December 15, 2014 12:51 pm

An in-depth analysis on how India and China are emerging as key players in the global construction equipment industry
 The global construction equipment (CE) industry is linked to several growth factors, i.e., GDP growth, urbanisation, and infrastructure development all of which have a positive outlook going forward. The world economy is projected to grow at a CAGR of about 3.3 per cent between 2013 and 2030. Main drivers for this strong growth are Rest of World with 7.4 per cent, Middle East and Africa with 4.1 per cent and the APAC region with 3.9 per cent. Urbanisation will continue to increase with 33 per cent of the increase in urban population between 2011 and 2050 coming from Africa and another 54 per cent coming from Asia. Both factors, GDP growth and urbanisation, will drive construction and infrastructure investments. By 2030, construction and infrastructure investments will amount to about 19 per cent of global GDP, US$ 11.8 trillion out of a total spend of US$ 18.5 trillion will be spend in emerging countries. On a cumulative basis, US$ 47 trillion are expected to be invested in key infrastructure segments between 2010 and 2030
Infrastructure spending is by no means limited to developing countries. The US is required to spend approx. US$ 2 trillion to rebuild infrastructure including roads, bridges, water lines, sewage treatment plants and dams. A four-year, US$ 302 billion transportation plan was proposed in 2014. The UK announced an US$ 320 billion investment plan till 2015 to improve the country’s energy and transportation systems. These initiatives compare favourably with the US$ 1 trillion that China intends to spend until 2016 to overhaul its national transit, water supply and electricity networks as well as to complete a 10,000-mile high-speed rail network by 2020.
As a consequence of this encouraging environment, the global CE industry will grow at about 4 per cent CAGR till 2017. India is the highest growth market, while China is de facto stagnant as shown in Fig. 2. As a consequence, India’s relative importance is set to increase and by 2017, India should amount to more than 25 per cent of China’s demand.
China: coping with post state-support hangoverChina’s CE market remains in a difficult situation due to economic restructuring, supply glut and slow down in real estate and mining. Policy makers switched economic focus away from investments and exports towards consumption. This has affected the CE market negatively and comes at a time when GDP growth rates have been slowing. Heavy stimulus spending intended to mitigate the 2008 recession led to the build up of dramatic overcapacities, especially, after stimulus reduction resulted in market contraction by about 40 per cent between 2011 and 2013 as shown in Fig. 2. For example, for wheel loaders Chinese capacity amounts to 145 per cent of global demand, for excavators the corresponding number is a still challenging 118 per cent. Tight credit, restrictions on multiple home ownership, and easing of prohibitions on overseas investments – all of which started in early 2014 – have affected the CE market as well.
While the pre-2011 growth rates are unlikely in the near future, the sheer size of the CE market makes China extremely important. China accounts for about 40 per cent of the overall global sales of CE. The spending power of the Chinese government is formidable, current reforms focus on faster investment in railway and shanty town constructions, easing reserve requirements for rural banks and tax breaks for smaller firms which will help drive CE sales. About US$ 100 billion will be spent on building 50 additional airports and extending the National Truck Highway System from 74,100 kms to 83,000 kms by 2015. Also, Chinese players are entering emerging offshore markets including Brazil, India, Russia and Africa with high quality products adapted to local conditions which will drive their volumes.
As a result, China’s CE is expected to steadily grow and reach about 290,000 unit sales by 2017. This amounts to a total market opportunity of about US$ 25 billion
Chinese overcapacity drives dragons to foreign shoresAs the Chinese market has grown, domestic OEMs have increased their share of the global CE market and are serious global contenders. Among the top 11 global CE companies, we find 3 Chinese companies: Sany (2012, #4), Zoomlion (2012, #5) and XCMG (2012, #11). China as a country is globally the third largest producer in value terms behind only Japan and the USA in 2013.
Heavy investments in capacity, large size and a dramatic drop in demand after the end of government stimulus in 2011 have led to chronic over-capacity, high competition and a major drop in profitability of large Chinese OEMs
In such a competitive market, both global OEMs and domestic Chinese players have adopted distinct strategies. Global OEMs focus on their key differentiators such as high equipment productivity and durability; superior product quality and performance; optimised total cost of ownership; and advanced product features and functionality. This positioning is in particular successful in the excavator segment, where Komatsu, Caterpillar and Hitachi account for more than 25 per cent of the overall market. Chinese OEMs have so far focused on low acquisition price; availability and low price of spares; basic product features and functionality; dealer location and network; flexible financing options and growth through M&A. With that they have cornered 57 per cent of the Chinese CE market with up to 80 per cent in the loader and compactor segment.
Over the past few years both domestic and foreign companies have been actively pursuing acquisitions to grow their market position. An overview over some of the M&A activities is shown in Fig. 5. Some of the takeovers were quite visible, such as the buyout of Schwing, a German major producer of concrete pumps, by XCMG and the takeover of Putzmeister, another German leader in concrete pumping, by Sany. For Chinese companies, takeovers and JVs are mostly driven by the desire to create an international brand, to acquire an international sales network and access to technology. International companies often try to access good enough technology and distribution networks via their take over and JV activities in China.
Moreover, CE players (both global and domestic) are expanding their business scope by playing across the entire value chain. Development of the product range to cover the full line of applications, 6S store concepts, loan/lease approaches and insurance, sale of replacement parts and rebuilt parts and remanufacturing are just some of the initiatives that players adopt to drive revenue and shore up bottom line. International players such as Komatsu and Caterpillar are focusing in particular on After Sales, Rental and sale of used equipment.
Despite strong commitment to the Chinese market, global players have not been able to replicate their international success in China. Take Komatsu and Caterpillar as examples. Komatsu’s global market share is 11 per cent vs 9 per cent in China (2012 data). For Caterpillar the situation is even more dire. The China market share is 7 per cent, not even a third of the global market share of 22 per cent. Lower market penetration is a consequence of high import content, premium products in a market that requires good enough functionality, delays in product customisation as well as in capacity enhancements.
As the domestic market slows, Chinese OEMs are increasing exports, especially in SEA, Africa and Latin America. Chinese exports can build on a number of competitive advantages. China benefits from scale effects and relatively low-cost labour. Typically Chinese OEMs can make products based on simpler technology with a minimum cost advantage of 15-20 per cent vs Western OEMs. China also has a strong footprint in infrastructure projects in Africa across power, transportation, and mining in 35 African countries. This can be leveraged to drive Chinese CE sales. As African and other markets are close to the demands in China (‘good enough’ vs ‘perfect’ products), this provides Chinese players with a natural product advantage. Last but not least, the quality gaps between Chinese and Triad products are also rapidly shrinking. Key markets for Chinese exports are Asia, Europe and Africa
The Chinese CE market is expected to stay extremely competitive, players need to take strategic actions to strengthen their respective position. Chinese players will need to leverage economies of scale to penetrate emerging markets via attractive pricing; enhance product quality and features through acquisitions in developed markets and invest in R&D to meet higher performance and quality standards; and last but not least improve after sales and service especially in emerging markets to drive up residual values and ensure repeat purchases. International OEMs need to find ways to serve price conscious customers via high-quality used equipment or lease-based/rental business models; customise their offerings for the Chinese and other emerging markets and provide greater versatility of equipment; and increase customer retention through better after sales service and maintenance programs.
India: overcoming policy inactionMultiple challenges need to be addressed in order for the Indian CE industry to achieve its expected “long-term” potential. India has bottomed out as far as its GDP and growth is concerned. Going forward, strong focus on supporting business is needed to sustain growth rates north of 7 per cent. Key policy bottlenecks, which hampered growth over the last few years, need to be solved and major infrastructure projects need to be consistently driven towards completion. Capital constraints due to low private participation and thin spread of government outlay as well as long working capital cycles and unfavourable tax structures need to be addressed.
The outlook on the construction sector is negative presently due to strained liquidity, unfavourable regulatory actions and stagnating order book . Leverage nearly doubled from 2010 to 2014 and reached a high level of 4.8 while interest cover fell to worryingly low levels of 1.7 over the same time period.
A recovering economy, huge infrastructure investments by the government and rising urbanisation will revive the CE industry. With the new government, expectations are that India’s GDP will grow at 6.2 per cent in FY15 and 7.1 per cent in FY17 which is sufficient to provide stimulus to the domestic CE industry. Substantial infrastructure investments of US$ 1 trillion under the 12th Plan will drive demand as well as increases in residential construction which is expected to grow at a CAGR of 14 per cent until 2017. Office space construction is expected to grow even faster (18 per cent CAGR till 2017). India’s urbanisation will add more than 160 million inhabitants to Indian cities by 2020 which will require infrastructure development, especially in Tier 2 cities.
The Indian CE market has the potential to grow at about 12 per cent CAGR to reach approximately 75,000 unit sales by 2017 from about 50,000 in 2012. As shown in Fig. 8, most of the growth will happen in the Crawler Excavator segment, which will double in volume by 2017. The back-hoe loader segment will remain the dominant segment by volume for the foreseeable future.
Foreign players ride the Indian tigers also for exportsThe Indian CE market is still small but is expected to witness strong growth; back-hoe loaders and excavators are the dominant segments. Back-hoe loaders will show subdued growth of 5 per cent, partially due to a high base effect and partially due to the shift in demand towards Crawler Excavators. The growth rate in this segment will be at a CAGR of 24 per cent from 2013-17 followed closely by a CAGR of 18 per cent in the Wheeled Loader segment.
The back-hoe loader is a clear winner-takes-all segment with JCB India garnering more than 63 per cent market share. In the Excavator segment, Tata-Hitachi has a strong position with 35 per cent market share followed by L&T-Komatsu with 22 per cent and Hyundai with 15 per cent.The CE market in India, while small by global standards, is extremely competitive and has players operating under different strategies. A number of Indian OEMs such as L&T, ACE, Escorts, BEML, and Greaves are present in the market. Most of these are long-standing players who have been active in India since pre-liberalisation days. Few have been in JV agreements in the past to gain access to technology. Besides the pure local players, a couple of JVs are still in operation and successful, namely, Tata Hitachi and Leyland Deere. Besides these JVs, most international players operate via fully owned subsidiaries (JCB, CNH, Sany, Komatsu, Caterpillar, Volvo, Terex, etc.).
Multiple reasons have encouraged global players to enter India through the 100 per cent subsidiary route. JV options are somewhat limited, especially when aggressive growth needs to be funded in India. Government policies are favourable and don’t require JVs for market access. India can also be leveraged for global exports. Most CE manufacturers are using their Indian operations to support export of finished units, aggregates, and components for their markets in Europe, Africa, Middle-East and South-East Asia. Last but not least, control and IP protection are easier to achieve in a wholly owned subsidiary rather than a JV.
Similar to the situation in China, India is a potentially lucrative, albeit difficult market. To be successful in India, CE players need to take strategic actions. As the Indian market matures, domestic players need to improve product specifications and quality. Established global players need to continue to launch market adequate, ‘good enough’ products and increase their aggregate or component localisation to achieve target costs and serve price conscious customers.
Both players will have to improve the sales and after sales experience and should explore opportunities for building rental or leasing business as current share of rental CE business is significantly below global average. India also needs to be leveraged as an export hub to drive economies of scale similarly to what OEMs such as JCB or Hyundai and Nissan in the automotive space have done.
In summaryThe global construction equipment market will continue to show solid growth going forward. Two key markets, India and China, will show strong growth in their own right, albeit with very different competitive dynamics. In China, overcapacity induced by large government spending will force local players to aggressively scout for opportunities in foreign markets. In India, natural advantages such as beneficial labour costs will drive foreign players to increasingly leverage the country for exports in addition to serving a relevant local market.
Authored by-
Dr. Wilfried G. AulburManaging PartnerRoland Berger Strategy Consultants Pvt. Ltd.