Industrials industry outlook
Volume 6, Winter 2021
Manufacturing companies may no longer be in crisis mode as they were earlier in the pandemic, but middle market leaders now find themselves exploring how best to remain flexible and resourceful in the long term. At the heart of this effort is the digitization of supply chains. Looking ahead in 2021, we expect the shift from traditional, linear supply chains toward more network-driven systems will accelerate as businesses seek to balance efficiency and growth for the future.
The renewed importance of the energy transition—especially under the Biden administration—will be another priority area for companies looking for growth opportunities. In this report, we examine why climate- and sustainability-related initiatives are crucial not just for energy companies but for the industrial space as a whole.
- New technological developments and their convergence, increasing amounts of data, and the widespread adoption of connected devices all provide impetus for disruption and incredible opportunities for managing supply chains differently.
- While many manufacturers may have expressed a desire to reshore sourcing and/or manufacturing, the calls for manufacturers to completely abandon China may be premature.
- We expect the emphasis on green initiatives to accelerate—especially for the auto, power and construction sectors—given the Biden administration’s expected focus on climate change.
- While the pandemic was initially expected to hinder energy company investment in new technologies that underpin the energy transition, time has proven the opposite.
Supply chains: Looking beyond COVID-19
New technological developments and their convergence, increasing amounts of data, and the widespread adoption of connected devices all provide impetus for disruption and incredible opportunities for managing supply chains differently. As manufacturers move forward, they must evaluate how best to take advantage of these tools and technologies to create greater interconnectivity in their supply chains and take advantage of growth opportunities, or risk their competitive position in the future of manufacturing.
As we begin 2021, the manufacturing industry is at one of its most pivotal moments in recent history as companies navigate the continuing impact of the COVID-19 pandemic on their operations. Most leadership teams have now shifted their focus away from immediate crisis response and toward long-term success and sustainability, and it has become clear that the agility, innovation and resourcefulness that companies demonstrated at the start of the crisis will need to become the standard. The companies that most aggressively adapt and evolve their operating model will be able to turn their response to this crisis into a strategic advantage.
Businesses have adopted priorities that include offering remote work options, creating a safe environment for employees, protecting their client base and enhancing business continuity plans in the event of a resurgence of the virus. Also in the wake of 2020, customer expectations—and how those expectations have changed—have become paramount. What customers are increasingly placing value on—tailor-made or “bespoke” products and a streamlined buying experience, along with more awareness of upstream risks related to human labor issues, intellectual property violations and sustainability, to name a few—will require companies to evolve to meet these shifting requirements.
Manufacturers are now reevaluating and, in most cases, accelerating digital transformation in every area of their value chain, from research and development to production. But ultimately, the greatest impact will be on their supply chain. Manufacturers were already facing supply chain challenges prior to COVID-19, including tariffs and rising labor costs in China (which has come to be known as “the world’s factory” and accounted for around 28% of the world’s manufacturing output in 2018, according to United Nations data). With recent advances in automation reducing some of the cost benefits that have long made overseas suppliers so attractive, the appeal of supply chain globalization for many companies had lessened even before 2020. A Gartner Inc. survey of 260 global supply chain leaders in February and March 2020 “found that 33% had moved sourcing and manufacturing activities out of China or plan to do so in the next two to three years.” Results of a survey conducted in June 2020 by industrial sourcing platform Thomas indicated a continuation of this trend; 69% of companies surveyed stated they were “likely” to “extremely likely” to reshore, compared to only 54% in February, Thomas found "Manufacturers are now reevaluating and, in most cases, accelerating digital transformation in every area of their value chain, from research and development to production. But ultimately, the greatest impact will be on their supply chain.”
Manufacturers are now reevaluating and, in most cases, accelerating digital transformation in every area of their value chain, from research and development to production. But ultimately, the greatest impact will be on their supply chain.
However, relocating or augmenting supply chains that have been built up over a generation is a complex and difficult process and current data does not support large shifts as of yet. Chinese exports to the United States continue to rise (as we show in the figure below) and the share of Chinese imports to the United States still dwarfs all of those from other Southeast Asia countries (shown in the second figure).
Therefore, while many manufacturers may have expressed a desire to reshore sourcing and/or manufacturing, the calls for manufacturers to completely abandon China may be premature. Multinational companies which sell to the Chinese market will stay and even expand as businesses continue to want access to the growing Chinese consumer base, as well as the fact that China continues to be the preeminent global provider of intermediate materials and components.
MIDDLE MARKET INSIGHT
We do expect that as middle market manufacturers seek to more effectively manage risk while seeking growth, the digitization of supply chains will accelerate, furthering the shift from traditional linear structures to more open, network-driven systems.
Supply chains built to last
What will this look like for manufacturers? The most nimble of manufacturers will move toward a digital supply chain operating model that provides real-time visibility, automation and control. Such models will enable manufacturers to anticipate and respond to supply and demand challenges more effectively, ultimately minimizing the impacts of those challenges.
Continuing digitization will allow traditional supply chain elements to transform more easily into seamless, increasingly integrated supply chain networks that allow manufacturers to better anticipate market changes and realign themselves to respond swiftly to any disruptions throughout those networks. These network-driven systems, commonly referred to as digital supply networks (DSNs), represent processes, organization structures and technologies that give companies clearer visibility into suppliers’ and consumers’ supply chains and how all of these supply chains connect. They leverage cloud-based platforms and control tower setups to connect, scale and ultimately integrate data from multiple sources. The resulting DSNs comprise a seamless integration of talent, information, financial and physical supply chains.
The path forward
Designing a more resilient and efficient supply chain while addressing increasingly complex customer demands requires all stakeholders and partners to work together. There are still barriers to doing so, including the lack of interoperable systems between companies, data privacy concerns, upstream data collection challenges and high adoption costs, but organizations will need to reevaluate the complex trade-offs between cost and customer responsiveness.
These changes will also have a significant impact on manufacturers’ workforce. A skills gap has been plaguing the manufacturing industry over the past decade and the ability to adopt and use new technologies and effectively leverage data and analytics will require employees with different skill sets, including significant digital acumen.
Manufacturers must position themselves for an unfamiliar future. The most successful companies will be those that can adjust their operating models to integrate advanced technologies in ways that allow their supply chains to adapt more easily to future disruptions.
Green is the new black
Sustainability and the effects of climate change continue to garner a lot of attention among businesses today. While this attention is definitely elevated within the energy sector, the broader industrial sector should also take note of the urgency around climate- and sustainability-related market demands. Climate activists, scientists and global bodies have flagged climate change as a critical issue and assert that in order to limit global warming to no more than 1.5 degrees Celsius, we will need to achieve net-zero emissions by 2050. While individuals and countries should all focus on environmental goals and apply energy efficient processes to reduce their carbon footprint, there are also business opportunities for industrial companies. We highlight below some of the opportunities that an increasingly climate-conscious world brings to the industrial sector.
In the U.S. industrial space, emphasis on green initiatives has gradually increased in the past decade. We expect this will accelerate—especially for the auto, power and construction sectors—given the Biden administration’s expected focus on climate change. In addition to policies that accelerate electric vehicle adoption, Biden’s campaign promises included modernizing the electric grid and transitioning the country to a renewable power infrastructure. His platform also focused on reducing emissions from buildings, which would boost demand for low-voltage electrical equipment. States and cities may be encouraged to adopt energy efficient codes for buildings and the private sector may be incentivized to retrofit 4 million commercial buildings and 2 million homes, per Biden’s proposals. This provides an opportunity for companies that develop connected lighting and energy solutions, energy efficient HVAC equipment makers, and electric equipment manufacturers and suppliers that can help lower energy consumption.
"While the attention on sustainability is definitely elevated within the energy sector, the broader industrial sector should also take note of the urgency aroun climate- and sustainability-related market demands."
The airline industry in 2009 ambitiously committed itself to reducing its emissions by half of 2005 levels by 2050. More recently, in 2020, the U.S. Environmental Protection Agency finalized greenhouse gas emission standards for commercial airplanes to align with international aviation emissions standards. While this maintains the competitiveness of domestically manufactured aircrafts, it also highlights the rising environmental consciousness in the industrial business.
Various governments, investors and corporations across the globe are increasingly signing up for the United Nations’ Race to Zero campaign, which aims for net-zero emissions by 2050. While Europe is far ahead of the United States in terms of climate control policies and mandates (which has accelerated electric vehicle investments), emerging economies such as India and China also rank high in transition to lower-carbon energy, according to Climatescope 2020, a Bloomberg survey for clean energy stakeholders that ranks economies based on power sector fundamentals, opportunities and experience. Companies operating in international markets should keep this shift toward lower-carbon energy in mind while designing products and competitive strategies.
Large industrial conglomerates are looking to their suppliers, mostly small and midsize companies, to help them meet their environmental and sustainability targets through energy efficient components and reduced emissions. Many U.S. companies have adopted the standards put forth by the Greenhouse Gas Protocol, which divides emissions into three categories. Many have previously targeted a reduction of GHGP Scope 1 and Scope 2 emissions (Scope 1 refers to emissions from activities under the control of an organization while Scope 2 relates to emissions from the generation of electricity consumed by the organization), and more recently companies have been increasingly setting all-encompassing targets that address Scope 3 emissions (which account for emissions related to supply chains and customers).
Numerous companies including Ford, General Motors, American Airlines, Schneider Electric and multiple energy companies have committed to net-zero emissions sometime between 2040 and 2050. Others have announced sustainability targets such as pledging to source 100% renewable electricity (3M), including environmental sustainability as a performance metric for executive compensation (Northrop Grumman), collaborating with customers to develop products that reduce emissions (Cummins), and earmarking significant portions of their R&D budgets for technology that protects the environment (Bosch). Some industrial companies have set targets to increase reusability and recyclability of products and/or waste based on circular economy principles.
While these are only a few examples, such goals indicate a tremendous opportunity for middle market companies to incorporate environmental and sustainability measures in their own operations to increase their competitiveness. This shift also highlights the incentive for midsize companies to design, re-design, and develop products and services that address this need to meet such green targets.
Regardless of whether the Biden government can succeed in its climate change agenda, U.S. industrial businesses will need to pay attention to climate friendly mandates from their customers and investors domestically and internationally in order to thrive in the future.
MIDDLE MARKET INSIGHT
Ambitious emission goals among larger companies indicate a tremendous opportunity for middle market companies to incorporate environmental and sustainability measures in their own operations to increase their competitiveness.
Energy transition expected to accelerate in 2021
While it is crucial that the industrial sector as a whole prioritizes environmental and sustainability initiatives into 2021 and beyond, these shifts will have especially important implications for energy companies.
The energy industry is emerging from a year of unprecedented volatility during which we saw the “largest single-year drop in global oil demand” (10%) on record, according to a December report from research company Rystad Energy. That decline was driven by the pandemic-induced lockdowns, decreases in road and air traffic, and overall slowdown of economic activity. These are just a few of the major shifts—along with increased investment in decarbonization and digital technologies—that will continue to shape energy industry trends and the overall outlook in 2021.
The energy transition has been in motion for decades, but the events of the past year have accelerated the pace of change. While the pandemic was initially expected to hinder energy company investment in new technologies that underpin the energy transition, time has proven the opposite; companies have in fact continued to invest in technologies or enhanced processes that drive the energy transition. Company commitments, across a range of industries, to reduce greenhouse gas emissions increased 78% in 2020 to 562 companies compared to 316 in 2019, according to research performed by the Science Based Targets initiative (SBTi), a partnership between several nonprofits and the U.N. Global Compact.
The 10 countries with the most companies taking action in 2020 are broken down as follows, with the United States in the lead at 87 companies.
This transition toward more sustainable energy sources is clearly an industrywide (and beyond) priority, but the ways in which organizations achieve their goals will vary depending on their size, position on the value chain and strategy. Transition efforts range from adhering to policy and prescribed emission limits to investing in new technologies such as carbon capture or diversifying the portfolio into renewables. Large multinational companies have the ability to set aggressive net-zero targets, pivot from their fossil fuel-heavy portfolios with diversification into renewables, and outlay capital for research and development in areas such as carbon capture and storage, advanced biofuels, natural gas technology, and fuel cell technology. Research performed by S&P Global Market Intelligence found that 21 of the 30 biggest utilities in the United States, 11 of the 30 biggest metals and mining companies in the world, and 11 of the 30 largest oil and gas companies in Europe and North America have set net-zero targets they aim to achieve by the middle of the century.
“Setting reasonable, short-term goals that reduce the footprint of the existing portfolio is a logical approach to achieving clean energy objectives while protecting the business.”
But where does this leave independent companies and middle market players? Most middle market energy companies, at least in the short term, are focused on viability, cash flow and profitability. Without the deep pockets of larger organizations and on the heels of a tumultuous 2020, these companies will need to balance protecting their core business with positioning themselves for success in the race to net zero.
MIDDLE MARKET INSIGHT
On the heels of a tumultuous 2020, midsize companies will need to balance protecting their core business with positioning themselves for success in the race to net zero. To do this, organizations should take advantage of the fact that many efforts toward clean energy go hand in hand with more efficient operations and support the goal of improving the bottom line.
To do this, middle market organizations should take advantage of the fact that many efforts toward clean energy go hand in hand with more efficient operations and support the goal of improving the bottom line. The electrification of field equipment, installation of vapor recovery units to recover vented gas, reduced flaring, and water recycling are just a few of the ways that operators are reducing emissions and costs at the same time, as noted in this white paper from energy-focused private equity firm Kimmeridge. Setting reasonable, short-term goals that reduce the footprint of the existing portfolio is a logical approach to achieving clean energy objectives while protecting the business.
The Biden administration’s aggressive clean energy platform will be another stimulus for the energy transition push in 2021. The new administration plans to revisit former President Donald Trump’s regulatory rollbacks for the industry, impose aggressive methane emission limits for oil and gas operators, and require public companies to disclose climate risks and the greenhouse gas emissions in their operations and supply chains, according to Biden’s platform. These changes will require energy companies to stay highly attuned to new developments and to understand the implications of policy changes in order to ensure compliance. As reporting requirements change, energy companies should revisit their methods of measuring and tracking emission data to ensure their methods are accurate and accepted by the EPA. Being prepared and nimble will be the name of the game as companies navigate the ever-changing energy landscape into 2021.