Continued challenges in the T&D business

In an article written about one year ago, we asked if 2019 was the year when companies in the T&D business would start to really go bankrupt. We have now seen that this started to happen and that the weak results in the sector are continuing, and in some cases even worsening.

Looking at the situation from different angels, we see also other symptoms of a business with problems. Utilities experience problems with many late deliveries of both complete systems like substations and with supply of equipment. A utility recently told us that far more deliveries from OEM’s and contractors are delayed than not. The reasons behind this can of course be debated and do vary from case to case. Some suppliers get late because they cannot pay their sub-suppliers and get their subcomponents too late. Another very common reason we have seen, is poor quality. Equipment does not pass tests or does not get approved in the final inspection. It has to be fixed before it can be re-tested, which takes time and causes delays and delay penalties. In other cases, manufacturing and test equipment fails and production is disrupted. This happens partly due to neglected maintenance and a low investment level over the years.

Poor quality and delays are often caused by subcontracting. In cost cutting efforts and in order to avoid capital expenditures, OEM’s have to an increasing extent outsourced parts of their value-added chain. If a transformer manufacturer outsources tank production, cores, insulating material and in some cases even windings, it is obvious that the risk for delays and poor quality increases. First of all, the in-house design department has to deal with and prepare drawings for different suppliers, often  in several countries. This increases the design time and also the risks of defects, simply of language reasons. Furthermore, the probability that all suppliers will deliver everything on time and at the right quality is rather limited, and in addition the internal ability to detect and correct small mistakes is reduced.

At the same time, most OEM’s and contractors claim that their business is extremely competitive due to overcapacity. How can virtually every supplier have delayed backlogs if this overcapacity really exists? After looking at some specific companies who claim they are the victim of a market with overcapacity, we begin to see a pattern. When they define capacity, they start by saying that ‘if we used our machine park optimally and run 24/7 with a zero failure rate and an optimal product mix, our capacity would be, to take an example from the transformer industry we saw recently, 50.000 MVA per year. In reality, we strongly doubt that 20.000 MVA per year is possible for that company, when un-manned shifts, test failures, big variations of the product mix, design capacity and limited and delayed sub-suppliers are all duly considered. If the fixed costs are spread over 50.000 or 20.000 MVA per year has a very significant impact on the full costs!

We do not see a simple and quick cure for this situation, especially as companies continue to bid below their full costs. We asked a simple question to an executive in the T&D business recently. We asked ‘how do you expect to ever make a profit if you constantly bid below your full costs’? He was surprised by the question, but realized that a big part of the problem was in his own organization, that simply bid too low and lacked the courage to lift the price on one single bid, despite a well loaded factory with a partly delayed backlog.

Our advice to the T&D suppliers that suffer from low or negative results and bad cash flow is:

1. Establish a realistic capacity level for the company taking into account all different aspects. This will avoid systematic under absorption of costs and provide a better base for cost calculations.

2. Perform professional root cause analysis (RCA’s) for quality and delivery problems that occur. Learn from you mistakes.

3. Improve the sales process by applying a pro-active approach and highlight the values that your offer creates for the customer. Do not be afraid to lift the price. Low or negative margins are not the way to success, short- or long term.