Price/Margin/Volume Mindset Inhibits Growth

By : Jim Pinto,
San Diego, CA.

Industrial automation companies traditionally market higher priced products in low volume. The problem is that no one wants to break price barriers because of the mindset - the self-fulfilling prophesy. You can open new markets by changing pricing structures and sales channels.

This article was published by:
Check out, November 2005

Industrial automation companies traditionally market higher priced products in low volume, inhibiting a broader range of applications because of high prices. The fear is that the only way to approach higher volume is by reducing margins. In my opinion, this is simply a “mindset”, a “thinking inside the box” problem.

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

Take for example, analog measurement. In factory and process automation I/O systems, the ratio of digital to analog is still 90/10, and often as high as 95/5. Analog measurements have traditionally been much more expensive. So, even when good, low-cost analog technology is commercially available, traditional pricing continues, supposedly providing higher margins.

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

A significant problem is that business plans, usually done annually, are mostly extrapolations of budgets – growth, production-costs, gross-profit margins, R&D, marketing & sales costs, overhead & administrative costs, and net profit. Companies (especially large, publicly held companies) are judged by the first and last items in that list – growth and profit. Senior management’s responsibility (and compensation) is to juggle all the other ratios to fit.

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

Industrial automation business seems to be stuck in the mold of being a slow-growth, stable business. This generates a mindset, perhaps even complacency that inhibits change. In my opinion it’s marketing myopia, an unwillingness to think "outside the box".

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

There are three avenues of organic growth:
  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.
When old business shows flatness, or decline, and new products are projected to contribute only minimally, attention turns to immediate contributors to other avenues of growth. For many major automation suppliers, this is systems integration – selling services to existing customers.

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

A quick review of most automation and controls magazines makes it evident that the products and services advertised are mostly directed to the fragmented, yet fairly specialized, industrial automation 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

The basic technologies of industrial instrumentation and controls include measurement, display, recording, and control of a wide range of parameters—temperature, pressure, flow, speed, level, and so forth. Products include a wide variety of sensors, coupled to programmable logic controllers and PCs, data acquisition systems, distributed controls, and software—embedded communications and networking, human-machine interfaces, and the like. This tremendous range of knowledge and experience can and should be applied to other markets that have similar requirements, but may not be considered traditional industrial automation applications.

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

Perhaps the biggest growth constraints in the industrial automation business are the sales & marketing 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 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:

Return to Index of all JimPinto Writings Return to Index of all JimPinto Writings
Return to Homepage Return to HomePage

If you have ideas or suggestions to improve this site, contact:
Copyright 2003 : Jim Pinto, San Diego, CA, USA