Breaking the Automation Mindset

By : Jim Pinto,
San Diego, CA.

The industrial automation business mindset inhibits growth and expansion in related higher-volume markets because of reluctance to change the ground-rules. In a flat or declining economy, everyone seems to be too busy staying afloat to consider new avenues of growth.

A version of this article was published by:
Automation World, April 2005

Industrial automation business typically markets higher priced products in low volume. In my opinion, this is simply a mindset. Growth and expansion into other related higher-volume markets have been inhibited because of reluctance to change the ground-rules. The fear is that new markets have different cost structures and sales channels which take time to develop. And in a flat or declining economy, everyone seems to be too busy staying afloat to consider new avenues of growth.

Most people think that high volume and low price means lower margins. But that is not necessarily true. High priced control systems 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 market a balanced value proposition. Simply lowering prices does nothing but initiate a competitive and debilitating downward spiral.

The problem is that no one wants to break price barriers because of the mindset that low price means low margins. So, everyone continues to market products at established prices to generate revenues that meet the business plan – the self-fulfilling prophesy of low volume.

The annual business plan process

A significant problem is that business plans, usually made annually, are typically extrapolations of previous budgets. They include the following projections: revenue growth, production-costs, gross-profit margins, R&D, marketing & sales costs, overhead & administrative costs, and net profit. Companies (especially large, public companies) are judged primarily by the first and last items in that list – growth and profit. Senior management’s responsibility (and attendant compensation) is to juggle all the other ratios to fit.

Once revenue is budgeted, the fastest way to reduce production costs and related overhead is to transfer manufacturing offshore; this can be projected to provide significant savings within a year. Typically, minimal attention is given to knowledge-transfer and the possibility of at least temporarily reduced quality.

The first "indirect overhead" costs to be squeezed are R&D (which has only a long-term effect) and administrative overhead (which is thought to have no immediate customer impact). Marketing and sales are usually treated as ratios, with scant recognition that a low or no growth business environment requires more advertising and sales efforts, not less.

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

Industrial automation business "box"

Industrial automation has long been stuck in the mold of being a stable, slow-growth, and low-profit business. This has generated a mindset, perhaps even complacency, which inhibits change. In my opinion, it’s more like marketing myopia, an unwillingness to think "outside the box".

Organic growth comes from expansion of old business, plus new business (new products and new customers). When old business shows flatness, or decline, and new products are projected to contribute only minimally, attention turns to immediate contributors to growth – which, for automation suppliers, has been systems integration – which generates lower margins and much higher service content. But that gets minimal attention because most financial managers don’t see the difference. In my opinion it’s a mistake for product manufacturers to offer systems integration because it puts them in competition with their own sales channels. And as a result, systems integrators forsake old loyalties and simply migrate to other suppliers.

Most major automation companies have gross-profit margins of 45-50%, and net-profits are typically 3-5% – the industry mindset. Many other large companies generate much lower gross margins, in the region of 20-25%, with higher net-profit margins, typically 10-12%. Some of this may be accounting variations, but the broad-brush differences are real. Traditionally, automation business is based on higher gross margins and lower net-profits, and it is difficult for them to think “outside” that box.

In the automation business only 2-3% is spent on R&D, with some lower than that. By contrast, many high-tech manufacturers spend 10-15%, some as much as 20-25%. One wonders what the impact would be if industrial automation companies doubled, or even tripled, their R&D investments.

Marketing & Sales channels constraints

Perhaps the biggest growth constraints in the industrial automation business are the sales channels. Industrial automation is indeed a specialized, fragmented market with a tremendously broad range of applications and environments, overlapping and diverse products and industries.

The sales channels are correspondingly confusing – a mix of direct sales, systems-integrators, distributors, representatives, catalogs and, more recently, Internet store-fronts. Traditionally, automation companies pick one primary channel and stick with it. But, especially during a decline, the urge develops to gain growth through switching sales channels, or utilizing more, and even all, channels. This results in cross-channel conflicts which are difficult to manage. The resulting confusion causes further slippage of revenue with budgetary impact.

During difficult economic periods, the confluence of all the problems outlined results in healthy weeding out of poorly managed companies; short-term thinking shows up in poor follow-through results. Companies that can adapt their mindset to suit the changing business environment will continue to generate growth and success

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Copyright 2003 : Jim Pinto, San Diego, CA, USA