Six Emerging Trends in the Capital Goods Sector

— Despite outperforming expectations in 2023, capital goods companies cannot rest on their laurels. Firms should begin preparing for six emerging industry trends to sustain and increase their momentum over the next several years.

Capital goods companies beat the odds in 2023. Many players outperformed expectations against shrinking backlogs, supply chain bottlenecks, and geopolitical tensions, with the industry recording 4.9% top-line growth. ^[1] This growth was primarily driven by the ability to sustain high selling prices and the support of government incentive programs. Profitability also saw a notable increase, with EBIT rising to 10.2% and EBITDA to 14%, both surpassing pre-pandemic levels. 

But the industry isn’t out of the woods yet. Short-term growth is expected to continue at a slower pace due to uncertainties stemming from continued geopolitical tension, interest rates, and the upcoming global elections. ^[1] Indeed, the Manufacturing PMI index in May shows that economic activity in the manufacturing sector is contracting. The PMI has decreased by fifty basis points to 48.7%. This decline is driven by decreases in new orders and order backlog, with the highest decreases being 3.7% and 3%, respectively. Inventory has only decreased by 0.3%, which may lead to overstocking, which is particularly noticeable in the capital goods segment. ^[2] 

These developments signal potential headwinds for capital goods firms, which should remain vigilant to these and other emerging trends. Drawing on insights from top-performing capital goods firms, we have identified the six trends set to shape the sector's future over the next several years. We also share several strategic imperatives for companies to capitalize on the opportunities and mitigate the challenges they present.

1. Reduction of Backlog and Shortening of Lead Times

After three turbulent years marked by the COVID-19 pandemic, supply chain disruptions, and geopolitical tensions, businesses are embracing tighter control over working capital, especially inventory management, to bolster cash flow through 2024. S&P Global Market Intelligence’s Supply Chain Edge observed that firms are shifting from "just in case" to "just in time" inventory strategies to navigate the post-pandemic economic landscape efficiently​. ^[3]​

This strategic pivot is not merely about minimizing costs but about recalibrating supply chain dynamics in an era of heightened uncertainty and fluctuating demand. The same report highlights a reduction in supplier diversification and an uptick in reshoring efforts, suggesting a collective move towards consolidating supply chain activities to mitigate risks and enhance operational agility​. ^[3]​

These trends reflect a broader realignment within the industry to stabilize supply chains and ensure that businesses are better positioned to respond to market changes. The drive towards more localized and streamlined supply networks is a prudent response to the complex challenges businesses have faced in recent years, setting the stage for more resilient and responsive operations moving forward.

2. Decarbonization and Energy Efficiency

Capital equipment is not just a substantial contributor to global emissions, representing 6.5% worldwide, but also a significant economic player, accounting for over half of the world's ore production and 13% of global value added. This sector vividly embodies the circular economy principle of "generating more value with fewer resources," highlighting significant decarbonization and resource conservation opportunities. As the McKinsey report emphasizes, this is not merely an environmental imperative but a substantial economic opportunity, potentially generating between $9 trillion to $12 trillion in annual sales by 2030 as markets shift towards low-carbon alternatives​. ^[4]​

The transition to net zero is poised to be the most profound transformation since the Industrial Revolution, necessitating an estimated $275 trillion in investment over the next three decades. Despite these numbers, the journey towards decarbonization, especially in sectors that are hard to abate, involves intricate and capital-intensive strategies. ^[4]​

A critical aspect of this transformation is increasing supply chain transparency, which enables companies to:

• Pinpoint and mitigate carbon emissions at a detailed level.
• Make informed decisions based on accurate data concerning carbon and cost reductions.
• Forge strategic partnerships with suppliers to ensure the availability of low-emissions inputs.
• Optimize cost efficiencies to maintain competitive pricing in a rapidly evolving market landscape​. ^[4]​​

Such transparency facilitates operational adjustments and aligns with broader corporate responsibility goals, positioning companies to thrive in an increasingly environmentally conscious market.

3. Expansion in Aftermarket Services

An analysis by McKinsey emphasized that "average earnings-before-interest-and-taxes (EBIT) margin for aftermarket services was 25 percent, compared to 10 percent for new equipment.” ^[5]​ This significant margin disparity underscores the strategic value of focusing on after-sales services, which offer notably higher profitability than new equipment sales.

The technological shifts within the industry are profound, driven by the advent of advanced inventory management systems and the integration of IoT for proactive maintenance. These innovations enhance spare parts availability and enable predictive maintenance strategies that preemptively address potential failures, thereby reducing downtime and maintenance costs.

Looking ahead, the trend towards outcome-based value propositions in the capital industry appears poised to accelerate. The shift towards long-term contracts with subscription-based payment models reflects a strategic pivot that distributes costs over time, thereby maintaining the equipment on the manufacturer's balance sheet. This model not only ensures manufacturers' adherence to performance commitments but also mitigates the capital expenditure for customers, potentially supplemented by performance-based discounts.

The ability to manage after-sales services adeptly is becoming a competitive differentiator. As highlighted in the McKinsey report, this requires a strategic reevaluation where companies "benchmark themselves against players in other industries" to identify opportunities for improvement and refine their service offerings​. ^[5] This strategic focus fortifies customer relationships, enhances brand reputation, and opens avenues for upselling and securing consistent revenue streams.

Prioritizing after-sales services is thus not merely a tactical move but a cornerstone for sustainable competitive advantage and long-term revenue growth in the industrial sector.

4. Rising Competitive Pressure from Chinese Manufacturers

China's economic ascent has been characterized by a model heavily reliant on low domestic consumption paired with high levels of investment, a scenario that has precipitated substantial overproduction issues. According to Charles Grant, Director of the Center for European Reform, “China’s huge trade surpluses in recent years have created a glut of goods looking for markets." ​^[6] This trend raises concerns about potential oversupply in specific segments of the capital goods industry.

Although the capital goods sector generally serves a niche market with products that often lack easy substitutes, the ramifications of overproduction could ripple into more standardized areas. Segments such as construction equipment, water flow, and piping systems, which are more uniform in nature, could particularly feel the impact. Historically, this sector has demonstrated resilience by successfully passing on increased costs of raw materials to customers. However, the current landscape may shift due to the intensified competition spurred by Chinese producers engaging in price-dumping practices. Roland Berger's analysis indicates that despite challenges, “the industry was able to hold onto price increases to grow both revenue and profitability." ^[7]​ This could undermine the market power traditionally held by firms in this sector, challenging their ability to maintain profitability amid pricing pressures.

This strategic inflection point suggests that companies within these vulnerable segments need to reassess their competitive strategies by enhancing product differentiation or by exploring new markets less affected by these dynamics.

5. Improved Supply Chain Tracking

In the evolving landscape of global trade, the enforcement of sustainability policies like the Carbon Border Adjustment Mechanism (CBAM) and Country of Origin rules is reshaping the strategic imperatives for capital goods companies. 

According to the European Commission, the CBAM aims to encourage greener production by aligning the carbon costs of imports with those of EU products, thus leveling the playing field for EU producers by charging a carbon price on imports of certain goods. ^[8]

The application of country-of-origin rules is often seen as a measure to protect strategic industries by preventing trade deflection, which is typically not profitable due to the similarity in tariff levels among countries in free trade agreements and additional transportation costs. ^[9] This underscores the need for companies, especially in the capital goods sector, to increase supply chain visibility to adapt to these regulations and sustain their competitive edge.

For capital goods companies, these developments necessitate visibility into their supply chains. The ability to trace component origins and associated carbon emissions is vital for compliance and maintaining competitiveness under these new frameworks. Thus, businesses are urged to leverage the tools provided, such as the CBAM transitional registry, which facilitates the necessary reporting and compliance. ^[8]

6. Easing of Supply Chain Pressures

The recent uptick in the Global Supply Chain Pressure Index (GSCPI) to -0.48 in May from -0.92 in April signals a moderate improvement in supply chain conditions, yet still lags behind the historical average. ^[10]​ This increment, however minor, marks a shift from more severe disruptions experienced previously, reflecting an evolving landscape in global supply chains.

It's important to consider that the GSCPI is calibrated against historical norms, which means it primarily highlights deviations from these established averages. As a result, even a reduced index value can still signify considerable ongoing pressures in the supply chain. This is partly because the dramatic disruptions of recent years, such as those initiated by the COVID-19 pandemic, have recalibrated what constitutes 'normal' conditions, setting a new baseline that includes some level of disruption as standard. ^[10]​

The GSCPI also highlights the importance of resilience in supply chain management. The index incorporates a variety of indicators, including those related to cross-border transportation costs and other logistics metrics, which help in understanding the multifaceted nature of supply chain pressures. This approach is crucial for businesses as they navigate both commonplace operational challenges and low-probability, high-impact events—often referred to as "black swan" events—that could drastically alter the status quo. ^[10]​ For example, the recent Crowdstrike IT outage, which brought major segments of global commerce to a standstill, served as a reminder of the fragility of the world's technological infrastructure. As much as pressures abate, it is likely that significant disruptions will continue affecting global supply chains.

For businesses, the practical takeaway from these observations is the need to enhance their ability to respond quickly and adapt to sudden changes or disruptions in supply chains. Developing strategies for resilience, such as diversifying suppliers and increasing inventory buffers, could be vital in mitigating the impact of both predictable fluctuations and unforeseen crises.

Three strategic imperatives for capital goods players

Success in volatile and complex global markets like capital goods necessitates companies “running to where the ball is going”—not to where it is. The proverbial ball is headed toward organizations with advanced planning capabilities achieving better financial performance than the competition. ^[11]​ Indeed, according to new research from Accenture, companies with more mature planning and decision-making capabilities are 23% more profitable than their peers. In whatever manner the aforementioned trends develop in the coming years, capital goods players can set themselves up for success by taking the following three strategic imperatives seriously.

1. Collaborate with the extended supply chain to improve cost, lead-time, and net-zero compliance, metrics

Capital goods companies should prioritize collaboration with their extended supply chain partners, including suppliers, manufacturers, and logistics providers, to enhance cost efficiency, reduce lead times, and ensure compliance with emerging sustainability regulations. By working closely with these partners, companies can identify and implement cost-saving measures, streamline operations, and adopt sustainable practices. This collaborative approach helps companies achieve more efficient operations and faster delivery times while also positioning them to meet or exceed regulatory requirements for net-zero compliance.

To achieve these goals, companies should assess their current supply chain state, engage with partners to develop joint cost reduction and sustainability initiatives and implement technology solutions for better visibility and control. Continuous improvement through regular review and adaptation of processes is essential to maintain progress in cost efficiency, lead-time reduction, and regulatory compliance. This strategy enhances operational efficiency and customer satisfaction and provides a competitive advantage by differentiating companies as leaders in sustainability and innovation.

2. Develop better visibility, forecasting, and planning capabilities for the aftermarket space to continue driving profits

Firms should prioritize enhancing visibility, forecasting, and planning capabilities in the aftermarket space to sustain and boost profitability. Implementing advanced inventory management systems and predictive maintenance technologies enables better management of spare parts availability and maintenance schedules. This proactive approach minimizes downtime and maintenance costs while ensuring higher customer satisfaction.

Focusing on the aftermarket allows companies to access higher-margin revenue streams, significantly enhancing overall profitability. Improved visibility and planning capabilities reduce operational inefficiencies and create a more responsive and reliable service for customers, driving continued growth and financial performance.

3. Invest in future-proof planning capabilities to ease the pressure on capacity

Investing in advanced planning capabilities is essential for capital goods companies to manage capacity pressures effectively. By adopting sophisticated planning software for accurate demand forecasting, capacity planning, and resource allocation, companies can better navigate demand fluctuations, optimize production schedules, and ensure timely product delivery.

This strategic investment in future-proofing planning processes mitigates the risks associated with capacity constraints and positions companies to capitalize on future growth opportunities. Enhanced planning capabilities allow firms to remain agile, respond faster to market changes, and maintain a competitive edge in their industry.

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