Anyone who has worked deals in the industrial engineered products and components markets in the last decade likely encountered a common diligence issue (although the issue is by no means limited to that sector): the threat of low-cost imports to “higher-cost,” and perceived “higher-quality” European or American suppliers.
Two recent cases – both in air handling components – highlight the very different scenarios that emerged in two seemingly similar industry spaces. One faced an emerging low-cost (in this case, Asian) import threat; the other was very secure. What drove this difference?
We find there are a few common factors that contribute to increased competition from low-cost imports:
- High “value-density” – products can be shipped longer distances more economically, if they have greater “value-density”
- Acceptably long lead times – customers and processes that have limited issues with long lead times necessary for low-cost shipping options
- Global customers – OEMs with global manufacturing bases may be able to leverage first-hand experience in a low-cost location where a low-cost supplier is the local supplier to ‘try before they buy’ globally
- A low degree of custom engineering (and non-critical components) – product that is both highly-engineered and low volume high mix (LVHM) in nature often reverts to local suppliers, where design and engineering can be iterated rapidly. Even in HVLM applications, if the cost of failure/downtime is very high relative to the cost of the product, then it may not be worth the risk of offshoring
- High relative cost/and high labor quotients – more expensive components generally receive more attention from procurement and, all else equal, are more likely to be offshored
- Industry regulation – e.g., A&D requirements for domestic suppliers
- Importance of pre- and post-sale service – and the ability for low-cost competitors to access a channel (e.g., if channel is captive to current OEMs, then it can be very hard to break in)
- Tipping point – Quality among foreign suppliers is changing and perceptions and biases have changed, too. Superbly high-quality products are designed and built overseas (and suppliers understand the opportunity) and engineers know how to measure and determine quality
As referenced in our recent air handling experiences, even two apparently similar industries can be affected very differently by low-cost imports. As such, this is a diligence topic where reliance on previous expertise in a “related sector” can lead to logical, but highly inaccurate, conclusions.
A more thorough, research-based approach should address a couple of key issues:
- First, never underestimate how much and how quickly things can change. Additionally, you must be alert for the early clues, and become reasonably good at early fact-pattern identification. Customers change behavior based on the markets that they participate in (among other reasons) and the acquisition target companies’ competitors may very well be undergoing a transformation in their own capabilities or strategy – so, again, early fact pattern identification and recognition are paramount
- Second, consider the possibility that imports are “disguised.” You will regularly run into companies whose headquarters are and brand is domestic but whose products were, in fact, almost entirely core-manufactured in China. These products may bring significant price pressure to the industry. A good VoC effort needs to examine the degree to which customers are aware of these facts and whether they impact choice
- Finally, based on the results, consider that there are advantages to becoming a “disguised” low-cost producer, and that this transformation may be a strong part of the value generation plan
