Electronics and Profits

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Electronics and Profits

As the electrical industry merges into the electronics industry, I thought it appropriate to review the financial implications of that transition. I recently reviewed a summary of margins and net earnings for technology sectors of consumer electronics*. The summary compared 5 notable companies (Sony, Toshiba, Philips, Apple and Canon) and showed that of those 5 companies, the GM’s ranged from 25% to 45% and the summary of net earnings revealed that only 1 company actually made money. The money-maker was no surprise… Apple.  I also reviewed an analyst’s summary** on Acuity Brands that expressed concern for their future earnings due to the industry move to LED. His position was that Acuity was late to the LED game and would have to revise their supply chain systems to reflect the rapid cycle time for product development and absorb significant increases in R&D expenses. The analyst compared Acuity’s performance to Zumtobel’s performance and concluded that Acuity was well behind their transition to LED which has compromised Zumtobel’s financial performance. The short story: Acuity should expect similar diminishing results.

The nuances of any individual sector or company’s performance are varied enough to cause me to pause about over-generalizing on the forecast for the entire industry. However, the realities of the impacts of ‘electronic’ are endemic throughout the industry. If we looked back to those good ‘ol days of mid-1990’s, most electrical companies were 90+% ‘electrical’. The vast majority of electrical manufacturers in the 90’s did not have a pure R&D department and I can’t think of a company who had a CTO in place in the early or mid-90’s. There are exceptions, certainly, especially companies involved in factory automation like Rockwell or Eaton, but the bulk of the industry was more than happy to accommodate electronic requirements on a transactional approach as an add-in to their traditional product line. Add-ins were usually treated as a supply chain issue as well; buying the componentry to configure or simply assemble into their traditional products.

The tsunami of electronic gear that has moved into the US in the past 5-10 years has brought extraordinary changes to the manufacturing base. The impacts range from RFID devices for asset management to controls and sensor development that directly impact the installation and operation of traditional products to the absorption of electronic communication media into the workforce. The need for electronic R&D is now a virtual necessity to nearly any company in the electrical industry. The impacts of electronics extend throughout the industry; technical training for sales organizations, customer definition or channel strategy (and training), operational processes, supply chain sophistication, leadership talent and financial management.

So let’s talk about money… in the example above of the 5 tech companies with GM’s between 25%-45%. In the 80’s and mid-90’s it was common for lighting manufacturers within most categories (commodity fluorescent is an exception), to have GM performance well in excess of 50%. EBIT performance could be above 20% within a well-managed company. It was EASY to make money in lighting because the product make-up was fairly simple. Indoor lighting consisted of stamped sheet metal enclosures and spun aluminum reflectors. Outdoor lighting was mostly die-cast aluminum enclosures with stamped or hydro-formed reflectors. Material costs were low; labor wasn’t a huge cost so most of the gross margin dollars were allocated to business development: sales, catalogs, marketing, entertainment and sales incentives (rebates, co-op dollars, cash discounts, sales programs, etc.). R&D costs were negligible. Product life cycles were measured in decades, so inventory obsolescence was non-existent. Scrap rates were small, supply chains were simple: steel, wire, ballasts, corrugated and aluminum comprised the bulk of purchasing’s purview. That was then.

Electronics has ushered in an era of rapid product development with life cycles that are measured in months; with significant exposure to obsolescence, warranty claims and loss of market position. The technical attributes for your design team now requires that you have EE grads who understand integrated circuitry design as well as software and a host of issues that cause traditional electrical contractors to glaze over. Your supply chain team also requires sophisticated buyers who can grasp the essence of IC’s, chip-on-board and software design vendors who can deliver on time to a price point that moves quarterly.

All of the technical aspects of the new industry require sophistication throughout the employment ranks. That comes with a price. EE’s command significant compensation packages and are actively scooped up from graduation at salaries that unsettle internal equity HR policies.  Training staff, CTO’s, business development people, marketing, supply chain and leadership talent who ‘get it’… all cost money. The view for the future of making money in the electrical industry is changing and it’s not a pretty picture.

LED will have financial impacts that are easily predictable. In the short run (1-2 years), LED will add GM dollars to the company (and revenues), at a loss of GM percentages. As LED approaches majority adoption (2- 3 years), GM percentages will begin to decline rapidly. Earnings will fall accordingly. The competitive market will endure a rash of acquisitions, including putting the largest legacy manufacturers in play.  There will be hundreds of fallouts to many of the new entrants who entered the US market with dreams of picking up small market share in an enormous market. Market ‘correction’ will be unkind to those who thought that a sales strategy of selling the brightest, cheapest and best would lead to a real company.  Markets don’t respond to sales slogans, they respond to sales relationships.

For the survivors, the demands of adapting to a technology that has multiple buying influences and challenging integration issues with complementary or competing technologies will incur rising SG&A expenses. Operational changes will challenge capital budgets and rapid product cycles will require new approaches to operating processes and financial controls. In short, the picture looks much more like the 4 companies with so-so GM’s and no earnings. It will take time for the survivors to learn to manage in a moving target market.

And at the end of this cycle of maybe 10-15 years, the world will be far better for the changes. LED will revolutionize construction practices; significantly slash energy consumption and create a larger overall marketplace for the remaining companies who will be competing in the newly formed “building automation” industry. It’s a Renaissance and it will be exciting to watch it mature; for those who remain.



**Sterne Agee