conomics Digital economy and structural change

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1 Digital Economy Economics March 18, 2003 No. 36 conomics Digital economy and structural change The mechanical engineering and automotive industries online marketplaces on the advance? Editor Hans-Joachim Frank Technical Assistant Martina Ebling Frankfurt am Main Germany Internet: Fax: Managing Director Norbert Walter Horizontal and vertical marketplaces are becoming increasingly important for the mechanical engineering industry. In this way, mechanical engineering companies use horizontal marketplaces for trading in indirect goods at industry-wide level for the procurement of MRO consumables and office material. Processing costs can potentially be reduced by 10% to 30% by using horizontal marketplaces. Vertical marketplaces serve the mechanical engineering industry for trading in direct goods within the sector. Estimates indicate that vertical marketplaces facilitate a potential saving of 10% in product costs for direct goods. In this connection, it is important to be aware that by lowering product costs by 10%, depending on the company, total costs can be cut by up to 6%. In principle, mechanical engineering standard or mass-produced articles (e.g. basic ball-bearings, pumps or tools) are better suited for online marketplaces than complex special machines (e.g. hi-tech textiles, paper or printing machines). The automotive industry is one of the industries in which B2B electronic trading has become successfully established. One crucial reason for this is, in contrast to other industries, its oligopolistic market structure, which facilitates the setting up of industry-specific marketplaces. Another reason for its relatively high importance is the fact that even before the internet hype began, a large number of electronic networks were already in place between suppliers (one of which is the mechanical engineering industry) and automobile companies. The use of e-marketplaces in the extremely competitive automotive industry leads to intensified price pressure; especially in the case of standardised goods. For instance, reductions in purchase prices of up to 15% can be achieved via online auctions. In contrast, in the case of complex products, which are developed in a joint venture between the participating companies, the partnership aspect becomes more significant. Furthermore, when choosing the supplier for more complex goods, other aspects besides price also play a role: in particular, quality, innovation, the company s ability to meet deadlines as well as the after-sales service offered by the company. Josef Auer (josef.auer@db.com) Eric Heymann (eric.heymann@db.com)

2 conomics The mechanical engineering and automotive industries online marketplaces on the advance? Mechanical engineering: heterogeneous range of products poses challenge for marketplace operators A feature of modern industrial companies is the utilisation of machines to produce a wide range of goods such as foodstuffs, clothing, magazines, pharmaceuticals, aircraft, power plants and buildings. Given the key role of mechanical engineering in producing goods, its customer structure is significantly broader than that of other industrial sectors. The manufacturing industry consumes nearly three-quarters of mechanical engineering output. Trade and services account for just under 12%. The mechanical engineering industry s most significant consumer is mechanical engineering itself (23% share) followed by a wide margin by the automotive industry (roughly 10%). On the supplier side, a similarly heterogeneous picture emerges: 61% of mechanical engineering consumption is related to the manufacturing industry; this consumption is dominated by mechanical engineering products (25% share ), followed by electrical engineering (11%). Online marketplaces are playing an increasingly important role in mechanical engineering. Since the typical mechanical engineering company primarily faces other engineering companies both on the supply and demand side, it makes sense to look at online mechanical engineering marketplaces. Furthermore, as a result of the heterogeneous nature of the client structure within the industry, it would seem fitting to analyse the significance of such marketplaces for the mechanical engineering industry in terms of a meeting place with other industry branches, especially marketplaces for capital goods. Marketplaces reduce product and processing costs As is the case in almost all other industries, horizontal and vertical marketplaces also play a role in mechanical engineering. In this way, mechanical engineers make use of horizontal marketplaces for trade in indirect goods at an industry-wide level and C goods comprising primarily the procurement of MRO consumables and office materials. A KPMG survey of German mechanical engineering companies showed that, from a point of view of time, roughly 80% of time used by purchase departments is taken up in procuring relatively insignificant office material or C goods, which, however, make up a mere 20% share of the procurement volume. A typical, traditional procurement procedure results in process costs of around EUR 100. A Diebold study of the capital goods industry, conducted in conjunction with the VDMA (German Engineering Federation), highlights the use of horizontal marketplaces bringing about a savings potential of 10% to 30% in process costs. Vertical marketplaces enable the mechanical engineering industry to trade in both direct and industry-specific goods. According to Diebold, only 20% of all orders, but 80% of the entire order volume, are attributed to direct goods which go directly into production. Given the sustained value of direct goods, which is higher than that for indirect goods, the reduction of product costs is in the foreground. According to Diebold, vertical marketplaces facilitate a 0.5% to 10% savings potential in the Online B2B trading sales 2001 Vehicle construction Mechanical engineering Electrotechnology Logistics Source: Forrester Research, 2002 EUR bn Mechanical engineering*) *) Sales development in European B2B trading Source: Forrester Research, 2002 Electrotechnology*) % yoy *) Sales development in European B2B trade Source: Forrester Research, 2002 % yoy Economics

3 conomics product costs of direct goods. It is important to mention at this point that depending on the company a 10% reduction in product costs leads to a reduction in total costs of up to 6%. In principle, mechanical engineering standard or mass-produced articles (e.g. basic ball bearings, pumps or tools) are better suited for online marketplaces than complex special machines (e.g. high-tech textile, paper or printing machines). Important horizontal and vertical marketplaces One horizontal marketplace that has gained notice is T-Mart, which is specialised in procuring low-value consumable goods such as office and repair material, as well as MRO products. Besides the other advantages of horizontal marketplaces, such as the reduction of process costs, duration and purchase inefficiencies, the marketplace enables the mechanical engineering company, the structure of which is more in line with an SME, to move into international procurement; the company has an attractive link to many online marketplaces throughout the whole world. Given that the automotive industry consumes directly one-tenth, and significantly more indirectly, of all mechanical engineering products, and is thus the largest industry customer apart from mechanical engineering itself, its marketplaces are equally important. These not only include (vertical) marketplaces such as COVISINT and SupplyOn, the marketplace of suppliers for suppliers, but also individual automobile manufacturers marketplaces, such as that of Volkswagen. From a mechanical engineering point of view, important vertical marketplaces include ec4ec and Componet because it is here that mechanical engineers meet their suppliers for direct materials. The ec4ec (E-Commerce for Engineered Components) marketplace focuses on mechanical and plant engineering. This marketplace makes it possible for companies to cover their sourcing and collaborative engineering activities in full. Collaborative engineering, which has major future potential and is the most engineer-intensive mechanical engineering sector, means the joint development and planning by providers and suppliers e.g. the optimization of CAD planning. Ec4ec offers a combination of advertising and free negotiation possibilities. In this way, as part of a purchaser-driven procurement process, potential suppliers are sent technical documents, sketches and specifications and requested to use these when making offers. The suppliers can then download and process these documents on their networks. This sometimes results in close development cooperation and competition with regard to concepts. Following the technical clarification process, the supplier makes its offer which can only be accessed by the purchaser. This means that marketplaces are more than an online place for trading goods; they also open possibilities for cooperation. The Componet marketplace targets the technical supplier industry. Its range covers, inter alia, mechanical engineering, electrical engineering, MSR technology and automotive and transport engineering products and services. Tools such as auctions, advertising and online orders make the negotiation stage effective. In the case of auctions, electronic agents automate the bidding; continuous online presence is therefore no longer necessary. The processing stage is supported by a logistics and export services specialist in addition to a bank (financial services provider). Horizontal marketplace T-Mart Main customer: automotive industry Vertical marketplace ec4ec and Componet Economics 3

4 conomics Industry-specific mechanical engineering marketplaces Via industry portals, the VDMA-e-market Internet marketplace offers a direct channel to companies and the products and services of leading mechanical and plant engineering companies and the respective professional association. The services factor should not be underestimated, especially in mechanical engineering, because significant differentiation and profit opportunities can be found in preand after-sales service. There are currently six online specialist marketplaces: motive power engineering, gaskets and washers, pneumatic machinery, power engines, pumps and precision tools. Specialist marketplaces for fluid technology, industrial image processing, assembly and maintenance technology, robotics and sensor engineering are all in the pilot phase. In addition, specialised marketplaces for materials handling technology and productronics are being set up. The cross-manufacturer industry platforms available to VDMA member companies are primarily expected to shorten the search and, thus, indirectly similar to other sectors contribute to cost reduction and improved efficiency. Nevertheless, framework agreements (containing essentials such as volume, but not details on exact amounts and article numbers) or the other usual dynamic price structure in B2B is not taken into account. Second-hand machines also show specific online potential; in this way, second-hand mechanical engineering machines are now being traded on the Internet-based bcee second-hand machines exchange. Mechanical engineering therefore uses horizontal and vertical marketplaces. Measured in terms of order volume, vertical marketplaces dominate trade in direct goods. In principle, standard or mass-produced mechanical engineering items are better suited for online marketplaces than more complex special machines. Collaborative engineering has an especially favourable outlook for the engineerintensive mechanical engineering industry. Automotive industry: online marketplaces already established The automotive industry is another industry where B2B electronic trading has become successfully established. Here, too, the initial stage of electronic trading was characterised by a number of mostly independent marketplace operators, who pushed into the new market segment, but disappeared soon after owing to a lack of success; this consolidation process has yet to be completed. Nevertheless, it is clear that some marketplaces are likely to exist for a long time. A crucial reason for the already major importance of electronic marketplaces today is the oligopolistic market structure of the automotive industry compared with other industries. On the buyer side, i.e. car manufacturers, there is only a small number of independent companies worldwide, which favours the foundation of industry-specific marketplaces such as COVISINT. Another reason for the major importance of electronic trading in the automotive industry is that a large number of electronic networks between suppliers and automobile companies were already in place even before the onset of the Internet boom (e.g. via orders forwarded automatically when certain inventory numbers were reached). In this context, electronic trading between vehicle manufacturers and their suppliers is nothing new. By the same token, industry-specific electronic marketplaces have significantly altered the supplier-customer relationships in the automotive industry. Vehicle construction*) % yoy *) Sales development in European B2B trade Source: Forrester Research Logistics*) % yoy *) Sales development in European B2B trade Source: Forrester Research Economics

5 conomics The dominant functions of electronic market places have thus far been catalogue management systems and the opportunity to assemble offers electronically as well as carry out online auctions. It goes without saying that time and cost savings are a major concern. Many manufacturers have already had positive experiences in this regard. For instance, by placing purchases via the Internet for selected goods, Volkswagen successfully reduced the lead time per order by 95%. Online auctions also allow the lead time to be reduced significantly compared to traditional procedures. What in the past often took months can now, to a certain extent, be processed within a few days. This constitutes a major advantage for the companies concerned if the buyer communicates its requirements regarding delivered parts to the marketplaces in good time. Thanks to this visualisation of demand, suppliers can better plan their production. In this way, warehouse stocks can be reduced. 15% cost savings through online auctions In addition to saving time, auctions are, in principle, also a way of reducing purchase prices. Experience shows that the prices generated by online auctions are roughly 10% to 15% lower than the prices achieved through traditional negotiations. According to estimates by Cap Gemini Ernst & Young, manufacturing costs per vehicle can be reduced by up to EUR 800 by using the Internet. Of course, a great deal of time is needed to prepare an online auction; this should not be underestimated. Depending on their complexity, the goods to be procured need to be described in detail, auction participants need to be informed in good time, the auction procedure has to be transparent and a company s own strategy must be discussed during the auction. These are the conditions for achieving the desired success. Collaborative engineering a vision of the future As in other sectors, until now it has primarily been MRO consumer goods, standardised catalogue parts, basic external parts as well as non-productive goods (e.g. office materials) that have been purchased on electronic marketplaces; the aforementioned auctions are the usual tool used here. The classic auction is less well suited to more complex modules, components or systems. Electronic marketplaces are also less significant here. However, in future, it is likely that these products will be increasingly available to order via the Internet. To this end, collaboration between purchasers and suppliers is possible as early as at the development stage, i.e. the joint development of products via a single marketplace; ideally this would also reduce the time needed for development. Collaborative engineering is still in its infancy. The same is true for virtual supply chain management or concept competitions whereby suppliers face the challenge of developing solutions for a specific problem. However, such models are a thing of the future. Competition will become fiercer The use of electronic marketplaces in the fiercely competitive automotive industry will mean that cost pressure will intensify further. This is particularly true for standardised goods as it is here that the purchaser s primary goal will be to lower the purchase price. By contrast, for more complex products which are developed as part of a joint venture, the partnership between the companies concerned becomes more significant. Thus we are dealing more with a win-win situation, i.e. both parties essentially benefit from this concept. Moreover, in the Time and cost savings as a result of online auctions Time and effort required for the preparation of online auctions should not be underestimated Auctions for complex modules and systems less suitable Marktplaces serve to intensify pricing pressure Economics 5

6 conomics case of more complex goods, other aspects besides the price are important in the choice of supplier. These include especially innovation, quality, the company s ability to observe deadlines and its after-sales service. By contrast, car manufacturers are the clear winners when it comes to standardised goods, whereas suppliers profits are on the decline. The increased pressure on the sales prices is certainly also a decisive reason why several suppliers are sceptical of the new procurement tool. Moreover, the Internet is a good disciplinary tool for car manufacturers as alternative suppliers can be found more easily via the marketplaces, thus giving them a secret weapon vis-à-vis their current business partners. All in all, it remains an undisputed fact that in future, no company will be able to afford not to approach its customers via electronic marketplaces. More and more purchasers consider this a condition for even accepting the company as a supplier. Restraints on electronic marketplaces Several restrictions still stand in the way of the automotive industry using electronic marketplaces more intensively. Worthy of particular mention is trust, which is often lacking in an unknown or barely known online business partner. Furthermore, technical software problems are still proving to be an obstacle. This is especially the case if suppliers have to participate in several electronic marketplaces with different software solutions in order to fulfil a purchaser s demands. In such cases, the cost-benefit ratio is also unclear to the supplier. Also irksome are the companies fears that they are relinquishing a competitive edge or advantages compared to competitors as, for instance, the transparency in the procurement business is substantially increased through online auctions and also through collaborative engineering. It is precisely here in the research-intensive automotive industry (especially car electronics) that this danger should not be underestimated. Suppliers ultimately fear that car manufacturers want to force more cost transparency to increase their influence on pricing. Consolidation only a matter of time Compared with other sectors, a smaller number of electronic marketplaces is expected to materialise in the automotive industry. For this reason, a further decline in the next few years is therefore a given. One reason for this is, in particular, the already mentioned oligopolistic product structure of the automotive sector. In a sector comprising only a few end-customers, it hardly makes sense to establish marketplaces to an excessive degree. In addition, car manufacturers are likely to transact business primarily via the marketplaces that they initiated themselves. When all is said and done, trading platforms like in other sectors need to attain critical mass to be able to survive financially. Arguably the most significant marketplace for the automotive industry is COVISINT a joint venture by General Motors, DaimlerChrysler and Ford, which Renault, Nissan and the PSA-Group have since joined. Commerce One and Oracle act as technology partners. The figures from this public marketplace are really rather impressive: more than 8,000 registered companies and almost 3,000 online transactions comprising a transaction volume of USD 82 billion in the past two years are clear indications of its success. At the national level, SupplyOn is worthy of mention. Participants in this marketplace, which is also public, are the automotive suppliers Bosch, Continental, ZF Friedrichshafen and Siemens VDO, all trading substantial proportions Standardised goods: manufacturers are the clear winners Lack of trust is major obstacle Only few marketplaces will survive COVISINT most important marketplace 6 Economics

7 conomics of their purchases via this portal (total purchase volume: approx. EUR 30 billion). One significant private marketplace is VW Supply Group.com, the supplier platform on which all eight Volkswagen Group brands according to their own figures transact almost the entire purchasing volume of over EUR 50 billion. Last year, more than 500,000 transactions were carried out in this marketplace with some 5,500 suppliers participating. A crucial advantage of these marketplaces is that as financially strong companies these shareholders can bear the costs incurred during the start-up stage. Moreover, the figures mentioned above already signal a great deal of importance for the companies concerned. The chances of survival for these marketplace are significantly greater than for independent marketplaces without backing from large companies in the automotive industry. Booming B2B market growth expected A current Forrester study on the Future of European B2B Business forecasts buoyant growth in the coming years. The study is based on a survey of companies from 15 European countries and 13 sectors. In Europe EUR 77.9 billion in sales, or less than 1% of business between companies was settled online in A level of EUR billion is already expected for 2004 (share: 10%). Further expansion to EUR 2.2 trillion is expected by 2006; so that 22% of entire trading between companies in Europe would take place via the Internet. 1 The traditional industrial sectors such as mechanical engineering and automobile construction are undergoing dynamic growth similar to that of the average sectors studied. In 2004, the share of Internet business in mechanical engineering and the automobile industry will also reach about one tenth of the respective B2B business. In 2006 the B2B share in mechanical engineering will be around 22% and even 27% in the automobile industry. VDMA sector experts believe that only half of the expansion forecast by Forrester is realistic in their sector. In hindsight, forecasts made at the zenith of the New Economy on the outlook for electronic marketplaces have generally proved to be overly optimistic. Since the Internet bubble burst, the forecasts have been revised downwards to a significantly lower level. While we believe there is no doubt that the entire B2B sector will continue to grow, we are nonetheless of the opinion that the upward slope of the expected growth curve will be somewhat flatter than expected today. In our view, a rise in the B2B share to about ten per cent of overall trade by 2006 is realistic. Josef Auer, (josef.auer@db.com) Eric Heymann, (eric.heymann@db.com) Share of online B2B trade in overall trade volume in 2006 (forecast) Electrotechnology Logistics Chemicals + Plastics Energy + Utilities Vehicle construction Metal industry Mechanical engineering Consumer goods Company-related services Textiles and clothing Foodstuffs Wodd, paper and cardboard Construction Manufacturing industry Source: Forrester Research % The absolute volume of sales stated in the Forrester study is not compatible with the figures cited by the marketplaces in the automotive industry; the Forrester numbers are lower. This is mainly due to differences in the way the statistics are defined, in terms of both region and content. Forrester bases its findings on primary data from Eurostat, surveys of companies from the respective sectors and information from the national statistical offices. The deviations help, though, to highlight the general difficulties with the data pertaining to e-commerce. Economics 7

8 conomics ISSN The mechanical engineering and automotive industries March 18, online marketplaces on the advance? Germany s broadband networks - innovation on hold February 17, 2003 Information & communication technologies - panacea for traffic congestion? December 11, 2002 Germany s venture capital market: prospects remain dim December 5, 2002 Free software, big business? November 22, 2002 E-government: large potential still to be tapped October 31, 2002 Business locations in a networked world - No death of distance August 27, 2002 Taxation of e-commerce - looking for solutions August 1, 2002 Biometrics - hype and reality May 22, 2002 Technology and work - the 21 st century and its challenges April 29, 2002 Online brokerage in Germany 2002: strategy changes and market shakeout April 19, 2002 B2C trading in the automotive industry: the internet is primarily April 18, 2002 a source of information Framework conditions for e-commerce: all in good order? February 11, 2002 Virtual marketplaces in the chemicals sector: January 24, 2002 B2B turnover expanding strongly All our publications can be accessed, free of charge, on our website You can also register there to receive our publications regularly by . For the print version please get in touch with: Marketing Frankfurt am Main Fax: marketing.dbr@db.com Publisher: Deutsche Bank AG, DB Research, D Frankfurt am Main, Federal Republic of Germany, editor and publisher, all rights reserved. When quoting please cite. The information contained in this publication is derived from carefully selected public sources we believe are reasonable. We do not guarantee its accuracy or completeness, and nothing in this report shall be construed to be a representation of such a guarantee. Any opinions expressed reflect the current judgement of the author, and do not necessarily reflect the opinion of Deutsche Bank AG or any of its subsidiaries and affiliates. The opinions presented are subject to change without notice. Neither Deutsche Bank AG nor its subsidiaries/affiliates accept any responsibility for liabilities arising from use of this document or its contents. Deutsche Banc Alex Brown Inc. has accepted responsibility for the distribution of this report in the United States under applicable requirements. Deutsche Bank AG London being regulated by the Securities and Futures Authority for the content of its investment banking business in the United Kingdom, and being a member of the London Stock Exchange, has, as designated, accepted responsibility for the distribution of this report in the United Kingdom under applicable requirements. Deutsche Bank AG, Sydney branch, has accepted responsibility for the distribution of this report in Australia under applicable requirements. Printed by: HST Offsetdruck Schadt & Tetzlaff GbR, Dieburg. Print: ISSN / Internet: ISSN