Crisis as a catalyst for change: How pulling back on innovation investments during crisis robs suppliers of long-term financial performance
Part 2 of 3 articles: In partnership with the Automotive News Data Center
For nearly a decade after the 2008-09 recession, the global automotive industry enjoyed sustained sales growth, plateauing at about 91 million units in both 2017 and 2018. Performance had been driven by economic growth and consumer confidence as well as product and process innovation.
Still, not all automotive suppliers had enjoyed consistent performance, based on an analysis by FTI Consulting (FTI) of more than 400 companies’ revenue and growth in earnings before interest, taxes, depreciation and amortization (EBITDA) from 2010 to 2019. According to FTI’s analysis, the companies fell into four categories: Performers, above-average revenue and EBITDA growth; Defenders, above-average EBITDA growth; Growers, above-average revenue growth; and Contenders, below-average revenue and EBITDA growth.
Part 1 of this three-part series explored how some suppliers in FTI’s analysis appeared to have lost operational and financial discipline since 2008-09 and offered recommendations to improve future financial performance. In Part 2, the focus turns to investing back into the business and innovation and examines the performance gap of those suppliers in FTI’s analysis that sustained investments in those areas between 2010 and 2019 compared with those that did not. Insights from interviews with about 20 executives also provide perspective on how the COVID-19 pandemic could reshape the innovation agenda in the industry and affect long-term growth.
Automotive innovation happens around the product (e.g., connected, autonomous, electrified, advanced materials) and business process (e.g., Industry 4.0, IoT, blockchain, automation, analytics). FTI studied how 140 of world’s top suppliers invested in R&D and capital expenditures (CapEx) between 2010 and 2019 to understand whether investments in innovation resulted in differentiated financial performance.
The analysis reveals that top-performing companies invested in innovation at a significantly larger rate. Performers invested 25 percent more in combined R&D and CapEx than Contenders, indicating that investments in product and process innovation indeed affect long-term financial performance. Defenders, those companies having maintained financial discipline, reinvested the least in innovation and consequently lagged revenue growth compared with Performers and Growers. And while Growers did invest in innovation, investments appear to have focused on chasing revenue at the expense of profitability (Figure 1).
A deeper look confirms that, with respect to growth and profitability, investment in the business and innovation is critical. Suppliers in the top decile of revenue and EBITDA growth, on average, outspent suppliers in the bottom decile by 45 percent on investments in R&D and CapEx. Moreover, the most profitable companies, measured by EBITDA percentage, outspent the least profitable in R&D and CapEx by more than 70 percent (Figure 2).
Technology executives interviewed by FTI and the Automotive News Data Center consistently felt that the role of nonincumbent technology suppliers would expand in product and process innovation, particularly if traditional suppliers pull back or delay investments in advanced technologies. Said one executive, “Frankly, while they push out their investments, companies like ours are going to win more deals.”
FTI’s analysis of a decade of financial performance of 140 top global suppliers demonstrates why investing back into the business and in innovation is critical to superior performance. Even through one of the most sustained growth cycles in the industry, there was clear differentiation in performance. Between 2010 and 2017, the top 15 spending companies among the 140 suppliers invested 16 percent back into the business based on combined R&D and CapEx spending, while the bottom 15 invested only about 2.7 percent. When the growth cycle slowed in 2017, companies that invested more performed better across multiple performance indicators in 2018-19 (Figure 3).
Executives interviewed said there may be a potential reduction in R&D and CapEx investments for some time. Suppliers will need to balance short-term cost-cutting without forsaking too significantly its long-term investments in innovation. But what to prioritize? From a product innovation perspective:
• Vehicle electrification: Growth in electric-vehicle technology and supporting infrastructure will certainly continue and may even accelerate in China and Europe as a result of government subsidies, increasing C02 mandates across the European Union and changing consumer trends.
• Connected and autonomous technologies: There is likely a separation in the near term of which technologies will gain steam and which will not. Early stage technologies with longer development cycles that require more R&D investment to mature may be shelved.
• Shared and micro-mobility: As a result of COVID-19, consumer skepticism of public transportation will likely continue. Global growth of car-sharing and micro-mobility are likely to result in response to the public’s transportation needs in a socially distanced future.
When it comes to process innovation and making investments in areas that help optimize the business:
• Supply chain: Investments in innovation that deliver visibility and predictability to the supply chain will be critical to managing cost and risk. Building and replicating regional supply chains is expensive, but technologies like blockchain, IoT and predictive analytics can help reduce spending, avoid duplication and sense risk and vulnerabilities.
• Manufacturing automation: Post-coronavirus manufacturing, warehouse and distribution facilities will need to comply with public health requirements, resulting in fewer workers working farther apart. Several executives voiced concerns that productivity may take a hit and labor costs might increase in the absence of investments in smart manufacturing technologies, automation, remote monitoring, etc.
“We’re going to continue reinvesting for the good of the long haul with an eye on the short-term response needed. If we can continue getting short-term returns — less than 12 months — we’re going to reinvest that way. The three- and five-year returns are hard ones, at least as we sit here today.” -Executive Interview
While investments in the above areas of innovation likely have the greatest chance of generating returns, rigorous prioritization of capital allocation will be required. Suppliers will need relentless focus on tangible ROI as well as discipline in implementing innovations. Suppliers should also consider collaboration and partnership opportunities to offset cost and risk, as well as identify opportunities to scale complimentary capabilities.
FTI’s analysis shows that companies able to find a balance of investing in short-term needs and long-term performance and do so while maintaining focus on their innovation agenda can generate superior financial performance and clearly separate themselves from others.