Call it the age of uncertainty — this post-Great Recession environment when a weak recovery and any number of troubling signs globally cast shadows on relatively strong recent profit results. The future for industrial companies is a somewhat confusing blend.
On the plus side, industrial revenues (unadjusted for inflation) in the first nine months of 2011 topped levels last seen in the peak year of 2008, and earnings in this period were up 25 percent compared to January through September 2010. Average net profit margins at industrial firms are relatively robust again: about 6 percent now, a 6 percent improvement over last year. Emerging economies drove most of this growth, as real GDP gains in developed nations slowed to a meager 1.5 percent in 2011. In addition, the Dow Jones Industrials Index was down only 5.7 percent compared to an 11.4 percent drop in the overall stock market during that period.
The bad news, though, is that there is bad news — and it can't be easily ignored. For one thing, consumers and companies are still hesitant to spend their money — the Purchasing Managers Index tumbled in the first nine months of 2011, to 51 from 61 — and unemployment remains stubbornly high. Concerns persist that a second global recession — a double dip— is increasingly possible. Perhaps even more disconcerting, no matter what happens in the developed economies, GDP growth is already slowing in the most important emerging nations.
Given this uneven blend of trends and forecasts, it's little surprise that industrial companies have been conservative strategically. This can be seen, for example, in the pace of mergers and acquisitions (M&A). Although at the end of 2010, industrial outfits were relatively flush — cash on hand surpassed 14 percent of revenue compared to an average of about 9.5 percent during much of the past decade — the popularity of M&A has flagged recently. In the first nine months of 2011, the number of deals fell by at least 25 percent.
Instead of acquisitions, most successful industrial companies have been content to cut costs, prune their product and business unit portfolios, deleverage and hoard cash. While that approach has perhaps put these companies in a position to navigate uncertainty, it is nonetheless a questionable tactic. Simply put, if industrial firms sit on the sidelines with their cash for too long, they may end up under-investing in their businesses and innovation — and minimizing their growth prospects.
Over the next few years, we believe, industrial companies should view the glass as mostly half-full. They should have enough cash on hand to weather a crisis or two, but more importantly, they should use this time to put their money to work, particularly when many of their rivals will likely be reluctant to make bold moves. In other words, this is a perfect moment for smart industrial companies to invest in developing the capabilities, assets, and strategic intelligence that allow them to achieve and sustain competitive advantage, and that prepare them to take a leading position in their industrial sectors when opportunities for growth emerge.
We define capabilities as the three to six distinctive strengths your company has (or should develop) to set it apart from competitors. Each capability is built on a combination of processes, tools, knowledge, skills, talent and organization. While we strongly believe that it is crucial for every company to make conscious choices about the capabilities that they need to develop or acquire, there are general capability guidelines for industrial companies that could be the starting point for a differentiated business model in this current dicey environment.
For example, industrial companies are discovering that functional capabilities — like IT, talent development, and managing supply chains — cannot improve organizational performance in isolation, no matter how strong these functions are. Instead, the future belongs to companies that distinguish themselves by integrating and blending capabilities from their most critical functions in smart and unique ways.
Be on the lookout for Part 2 of this blog. In the meantime, for more information, please visit www.booz.com.