What mechanical engineering firms can learn from the 2008 financial crisis
Continuing business after Covid-19
Mechanical and plant engineering companies are facing massive challenges as a result of the COVID-19 crisis. These come at a time when the industry was already experiencing a declining order intake. However, industry players have survived crises before. The 2008 financial crisis had a severe impact on order intake, revenues and EBIT margins. How did companies perform during that crisis and the years that followed it? What lessons can they learn for life after COVID-19?
Challenges for mechanical and plant engineering companies
Even before the COVID-19 crisis, the mechanical engineering industry was under pressure. Internal factors such as delayed investments, low margins and processes in desperate need of digitalization were creating significant challenges for companies. At the same time, external factors such as the slowdown in market growth rates, competition from emerging markets such as China and ongoing trade wars around the globe were squeezing companies on the order intake side. The COVID-19 crisis has now massively magnified these difficulties and presented the industry with a whole new raft of unexpected challenges.
Of course, this is not the first tme that the mechanical engineering industry has had to deal with a crisis. The 2008 financial crisis was of a somewhat different nature, originating as it did in the banking world. But nevertheless, it had a strong impact on the mechanical engineering industry, which saw a bigger decline in revenues than the shrinkage of the economy as a whole – a drop of 17 percent compared to a five percent decline in German GDP overall in 2009. The steps taken by companies then and their performance during and after the financial crisis provide us with some powerful lessons for the current crisis. They help us understand how the crisis will impact individual companies and the industry as a whole in the short, medium and longer term. And, most importantly, they suggest what actions companies should be taking now in order to soften the blow.
Key lessons from the 2008 financial crisis
To assess the impact of the 2008 financial crisis on individual firms, we created a composite company based on a sample of 17 representative companies across the mechanical and plant engineering industry. The figures below are based on the financial statements of these players from before, during and after the crisis.
What is immediately apparent is that, during the 2008 financial crisis, both revenues and EBIT margins took a severe hammering. Revenues fell by 17 percent, while costs only decreased by 13 percent. The fact that the drop in revenues was bigger than the drop in costs meant that companies struggled to retain their EBIT margin, which fell from eight percent in 2008 to four percent in 2009. For some companies, the severity of this decline pushed them into the red.
After the upturn in 2011, the industry experienced a phase of continuous revenue growth, with a CAGR of three percent between 2011 and 2018. However, players were not able to convert this growth into profitability. EBIT margins stagnated around six percent, lower than their pre-financial crisis levels. In other words, there was no long-term recovery of EBIT margins.
A major factor in this stagnation was expanding labor costs, which grew from 26 percent of revenue in 2007 to 29 percent in 2018. Clearly, the necessary efficiency programs did not occur during this decade of growth. This enlarged fixed-cost basis compared to pre-crisis levels makes companies particularly vulnerable in the current crisis.
After the financial crisis, companies also required more capital to generate the same level of revenues. Capital intensity was pushed into a "negative" ratio by an increase of 20 percentage points, from 85 percent pre-crisis to around 105 percent post-crisis. The capital accumulated during the crisis has still not been fully released, and current capital intensity remains around 102 percent.
Impact of the COVID-19 crisis – A tentative look forward
The situation regarding COVID-19 is changing daily, with preventive measures and political actions continuously evolving. This makes firm predictions impossible. However, drawing on our insights into the 2008 financial crisis, we can make a highly tentative forecast of what the full-year impact of the current crisis may be on the mechanical and plant engineering industry – with all the necessary provisos about making predictions in an essentially unpredictable situation.
Assuming that the economic standstill lasts a total of two months, we cautiously predict that 2020 revenues will be down around 21 percent on their planned level for the year. This assumes a roughly eight percent decrease in revenues for each month of shutdown, a drop of around 2.5 percent in prices for the year due to declining sales and the resulting capacity concerns, and a three percent drop due to other negative effects on demand, such as delayed investments.
EBIT margins, stagnant in recent years at around six percent, face pressure from the same factors. This will be buffered slightly by savings on material and labor costs. However, companies will need to work very hard to achieve a balanced budget with no new borrowing – the "black zero" proposed by German politicians.
Recommendations for companies
The performance of the mechanical and plant engineering industry during the 2008 financial crisis and the years that followed teach us some important lessons about what to do – and what not to do – in a crisis. We make six recommendations for companies based on our observations of the past.
- 1 - Reduce external spending and material costs
Reduce material costs by negotiating with suppliers and through insourcing. This is a priority in order to reduce the decline in profits. The Roland Berger Spend Compression approach can help reduce costs by applying a holistic savings formula.
- 2 - Avoid simple downsizing, but be open for 'right-sizing'
Rather than laying off staff, consider other options. "Short-time work" during and after the financial crisis enabled companies to cut labor costs by around five percent in 2009 while retaining essential skills. The fact that most employees kept their jobs formed a basis for the post-crisis recovery. For a short period, insourcing activities can further help avoid idle working hours. However, remain open to check whether there are activities that do not create value and can be given up – Now can be the time for these changes.
- 3 - Focus on core competencies
Use the crisis to review whether you can transition any non-core activities to different or better ownership. This will enable you to focus on your core competences and achieve productivity gains now and in the future.
- 4 - Employ a clever pricing strategy
Price reductions will be necessary during the crisis in order to stay in the game. If you do not employ a clever pricing strategy, there is a real danger that low prices will persist longer than necessary, damaging your profits. Rebates labeled as such remain a taboo, however.
- 5 - Make up for declining demand with service business
At the time of the 2008 financial crisis, many companies' service business was underdeveloped. Now, thanks to binding contracts with strict conditions, your service business should continue even during severe crises, compensating for revenue shrinkage to some extent.
- 6 - Keep an eye on capital efficiency
On average, generating revenue today requires 20 percent more capital than before the 2008 crisis. During that crisis, many companies neglected to monitor capital efficiency. Don't fall into the same trap this time.
Unquestionably, the COVID-19 crisis will have an even greater impact on the mechanical engineering industry than the 2008 financial crisis. The situation is grave, and no industry players will come out of the crisis unscathed. Is there life after COVID-19? Yes – but you will have to act quickly, accept the new reality and prepare to manage not just the crisis, but also the recovery.