Most people consider low price to mean lower margins. This is not necessarily true. A high priced control system may still only generate low margins. And too, low-priced, high value, high volume products could generate healthy margins. The key, of course, is to pursue a balanced value proposition.

High-priced, low-volume industrial products

For temperature monitoring, for example, thermostat limit switches are used to provide digital too-high/too-low information because analog measurements (using thermocouples and RTD sensors and low-level amplifiers) are simply too expensive. Similarly, analog measurements of variables such as pressure, flow, speed, load etc. are traditionally high price, low-volume. Though today’s technology offers significantly better value in many analog applications, tradition still dictates pricing and the analog I/O point-count remains low, with higher margins. Few have considered that the volume remains low because the price is too high.

The problem is that no one wants to break the price barriers because of the mindset that low price means low margins. So, everyone markets $ 1000 products and generates revenues that meet the business plan – the self-fulfilling prophesy of low volume.

The mindset – the annual business plan process

Once growth is projected (usually demanded by senior management) the fastest way to reduce production costs and related overhead is to transfer production offshore; this can be projected to provide significant savings within a typical budget-year, with minimal attention typically given to knowledge-transfer and the possibility of more complicated logistics and at least temporarily reduced quality.

After direct-costs have been reduced, the first “overhead” costs to be squeezed are R&D (which has only a long-term effect) and administrative overhead (which typically has no immediate customer impact). Marketing and sales are usually treated as ratios and the ratios are usually decreased. In a low or no growth business environment, there is often scant recognition of the need to increase advertising and sales efforts.

And so, in a flat economy, the cycle of failed forecasts continues.

The “lock-box” of business ratios

Most major automation companies have gross-profit margins of 40-50%, the industry mindset. Many other large companies in other businesses generate much lower gross margins, in the region of 20-25%. Some of this may be accounting differences, but the broad-brush differences are there. Traditionally, automation business is based on higher gross margins and lower net-profit, and it’s difficult to think outside that box.

In the industrial market, only 2-3% is spent on R&D, with some lower than that. By contrast, many of high-tech manufacturers spend 10-15% – Cisco 15-20%, with HP, Lucent, in the 8-10% range, and Motorola, Ericsson at 10-15%. One wonders what the impact would be, if industrial automation companies doubled, or even tripled, their R&D investments.

Growth through Services

1. Expansion of old business – selling more old products to old markets;
2. New products – selling new products to old markets;
3. New business – selling new products to new markets.

The fact that the Services business demands different types of knowledge and personnel, and generates lower margins gets minimal attention. Most financial “bean-counters” don’t see the difference. They think that it’s simply extending more control over existing customers and broadening the business base. It’s still within their “industrial” mindset.

In my opinion, this is a mistake because it puts suppliers in competition with some of their own sales channels – the systems integrators. As a result, many SIs who are caught in the squeeze forsake old loyalties and migrate to other suppliers.

For product suppliers, the short-term margin reductions in services, plus increased costs of developing and training service personnel, make this a rough road to hoe. Longer-term, it is changing the sales-channel structure of industrial automation.

Similar technologies, different markets

For industrial segment markets, packaging is “industrial” and intended for use in relatively harsh factory and process environments, with wider temperature limits. Though the technology and designs are very similar, packaging brings a differentiated view of “industrial” versus “commercial” products. Also, commercial products are typically sold in much higher quantities, demanding lower pricing and profit margins. Further, the products and services are sold through entirely different sales and distribution channels. It’s hard to migrate to a different mindset.

Broader horizons

As an example, one such growth arena is energy management. This market has a significant need for utilization of automation & control technologies and methodologies, yet has hitherto been considered a totally different market segment, because it is “commercial”. There are many, many other similar markets and applications that can be approached to generate new growth.

Marketing & Sales channels constraints

The sales channels are correspondingly confusing – a mix of direct sales, systems-integrators, distributors, representatives, catalogs and Internet store-fronts. Traditionally, automation companies pick one channel, and stick with it. But, especially during a decline, the drive develops to gain growth through switching channels, or utilizing more, and even all, channels. This results in cross-channel conflicts, which must then be managed.

The largest companies in the industrial controls business – Emerson, Honeywell, Invensys, Johnson Controls – seem to have developed a clear separation of their industrial and commercial businesses mainly because the sales and distribution channels are completely different.

On the other hand National Instruments is a good example of a company that doesn’t seem to be limited by the price/volume/margin mindset. It continues its growth trajectory by expanding its technology and products into a broad range of markets and applications – laboratory test & measurement, data acquisition and SCADA systems, industrial automation, process control, motion controllers & motor drives, machine vision & robotics, sound & vibration measurement.

During difficult economic periods, there’s a healthy weeding out of companies which are stuck in short-term thinking. Those that can adapt their mindset to suit changing technology and business environments will continue to generate growth and success.

Related links:

Gross Margin – The Overlooked Metric

The Link between price and profit margin in a global market

The path to maximum margins