Will suppliers to the T&D sector start to go bankrupt this year?

We recently published an article demonstrating how accessible markets have become to smaller suppliers over the past few years. The other side of that coin is that they often offer prices below their own cost to get a reference order, establishing a too low price-level, that is almost impossible to improve later.
As the new year is progressing, we start to learn the financial results for 2018 from contactors, OEM’s and component suppliers to the T&D sector. The picture we start to see is scary, as results are getting weaker and balance sheets look worse than ever. We have tried to understand why this is happening.
As a start, we had a look at market volumes and how that has developed over the past years. It is certainly true that several large projects were delayed in 2017 and 2018, but the regular market volumes were, as far as we can see, at the same level as previous years. We have not seen any dramatic loss of volumes that could have caused the profitability drop, so we must seek the reasons elsewhere.
We have earlier discussed the self-destructive behavior employed by too many companies, where production capacities are expanded despite flat market volumes and where attempts are made to fill the excess capacity applying very low or even negative gross margins, in the vain hope that the result at the end of the year will be saved by the extra contribution. This has been going on for 7-8 years now and is still common practice. This is something we will continue to follow and see if the destructive behavior ever will change.
Another area that need to be looked in to is the procurement behavior in place at most utilities. The most common model is that potential suppliers first must pass a prequalification process. This is sometimes a costly and time-consuming process, and at the end most applicants still get prequalified, even financially weak ones. We regard the prequalification process important and necessary but find it unfair that in some cases financially challenged companies are approved, just to keep prices down. After this, a bidding process start, where price and in applicable cases also losses are evaluated, and not so much more. Utilities claim that ‘as this bidder is prequalified, requested level for areas like quality, and HSE are considered OK and equal’. In some cases, where the evaluation formula actually considers other factors, the lowest bidders tend to get very similar scores, making it a price-race again.  After bids are received, further rounds of bargaining will start, often as e-auctions, where prices are even more squeezed. This leaves unhappy winners who are forced to cut costs to be able to produce what they have sold. A consequence is that areas like R&D and factory investments lose out. Other common effects are delayed deliveries, simply as sub-suppliers stop material deliveries as they don’t get paid and cheating with losses and performance ratings. The losers have no choice but to go on to the next customer, bidding even more desperately. Some utilities see that this process is not in their long-term interest and are in a few cases starting to reconsider their models. State Grid of China, the biggest utility in the world, has seen this and did recently introduce a model where not the lowest bidder, but the bidder closest to the average price among eligible bidders got the biggest volume.
The combination of self-destructive volume- and contribution margin-thinking and price squeezing buyers have left many companies, even big ones, in a zombie-like state. Why do so few than go bankrupt and vanish, we ask ourselves. There are, as we have seen, two primary answers to this. One is that companies that make money elsewhere keep injecting more capital in their loss-makers as it is extremely expensive and cumbersome to close a factory in many countries. Another reason is that such companies are cheap, and new owners can buy them for a typical price of 1 EUR, plus debts. Or even less. They can then inject some capital and then the same pattern is repeated for another few years.
2019 may be the year when this really change, as there are factories around who cannot find buyers willing to acquire them, even for a price of 1 EUR. What will happen to those when the cash runs out?
There is no easy cure to this issue. In a coming article we will discuss how the situation can be turned.

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