The power transformer industry is suffering from global overcapacity and low profit margins. Yet some manufacturers, notably the big players, are calling for a growth strategy. Why is that, and does it make sense?
Let’s first have a look at the market prospects. Since the peak around 2008, the market growth has been slow, while a lot of manufacturing capacity has been added. Taking HVDC projects out of the picture, the global growth is expected at 2-3% per year, of course with large variations between different markets. Meanwhile, if you look at the bottom-line (adjusting for various ways of calculating the margin), the current prices are at what for the global industry at best represents survival level. Considering the gap between manufacturing capacity and demand, the industry will on average be in survival mode for several years to come. The gap will slowly close because of market growth and business restructuring.
So, what about a growth strategy?
According to one school of thought, this would be the right time to take a bigger share of the market, to create a stronger position to capitalize on once the market has recovered. Of course, this requires some financial muscles and would therefore be an option only for the bigger players. I would also argue that, due to the structure and characteristics of the market, it would have a very limited impact. Public procurement principles and prequalification of suppliers will serve as a moderating factor. And, of course, the prices will be pushed down even further.
What about higher contribution to overhead costs? This has some merit to it, if it’s done to secure loading at capacity. Stepping beyond that has doubtful merits; does it really make sense to add capacity to a market suffering from huge overcapacity? You can count on being stuck with a large backlog with poor margins. And what’s worse, it will be very tempting to take higher risks and to underestimate costs. This has happened more than once.
Let’s now try a thought experiment. Assume that you own a significant share in the company you’re managing, or that your incentives are based on the share price. Let’s also imagine a corporation with many lines of business, some more profitable than others, but with healthy overall margins. Growth of a company with good margins has a nice multiplying impact on the share price; it is a promise of even larger profits to come. If the lines between the different businesses are blurred on the highest level, it doesn’t really matter from where the profit comes and from where the growth comes. The share price will get a nice push upwards.
So, what to do?
There’s nothing new under the sun. As everyone with experience of running a transformer factory knows; manage your backlog to secure loading and best possible total margins, get your quality right, drive operational improvements, and the results will come. Doing smart business is better than growth with poor margins, and keeping your factory nicely loaded is better than going for capacity increase. Back to the coal mine. Back to basics.
