Buyers
Manufacturers of construction equipment produce heavy machinery that is purchased by various construction companies, as well as dealers, throughout the world. Without these machines, construction companies would suffer greatly; slowing the process of their production and increasing the amount of labor required to complete a job. Following the Porter’s five forces model to evaluate the industry, there are several characteristics that are evaluated to determine buyer’s power in the market place.
Buyer concentration
Buyers have a great impact on the success or failure of any industry. When the market of an industry has more sellers than buyers, buyers have the power to control prices and quality of goods. However, when there are more buyers than sellers in the industry, sellers have the power to control prices and quality of goods. Specifically, in the construction equipment industry, there are more buyers than sellers.
As stated earlier, there are five leading manufacturers of construction equipment worldwide, Caterpillar, Komatsu, Terex, Hitachi, and Liebherr. These five companies, among others, offer high quality, well known equipment to consumers. Being that there are so few manufacturing companies within the industry compared to buyers, the sellers, or the equipment manufacturers, have the power over buyers. This proves the construction equipment industry to be an attractive industry.
Buyer Switching Costs
Switching costs are incurred when a company ceases a business relationship with one entity and begins a business relationship with another for the same purpose. The switching costs in the construction equipment industry are very minimal, if existent at all, for the buyers. Buyers have the choice of which company they want to purchase equipment from, and changing the brand of machinery has no cost impact on the buyer. In this industry, buyers have the upper hand as the different companies have not created switching costs limiting their selection.
Buyer information
Buyers have a significant amount of information that would influence their decision to purchase construction equipment. Although the buyers may not know how to create the product themselves, they have knowledge of the current state of the economy and its impact on the construction industry as a whole. When an economy is in recession, the construction industry slows, demanding less construction machinery. On the contrary, when an economy is thriving, more construction takes place, requiring more machinery. “It’s no secret that the Great Recession was difficult on all Americans and perhaps even tougher on the professionals who work in the construction industry. As often happens with economic slumps, the construction sector bore the brunt of the downturn, which began earlier and lasted longer than other industries” (Impact of the Great Recession, 2016).
It is impossible for any one industry to have control over the economy so in a recession, there is nothing the industry can do to promote sales. However, construction machinery is not a simple product to manufacture. Due to its difficulty, the sellers in the industry have an advantage over the buyers in the market.
Threat of backward integration
Construction equipment manufacturers not only build the heavy machinery they sell, but the parts required to do so are manufactured as well. Specifically, the engines required to operate the machines are produced by the equipment manufacturer as it increases profitability, rather than using an engine that another entity built. In addition to increasing profits, producing engines internally, promotes the company’s reputation; and allows them to better control warranty costs and customer service. The leading company in the industry, Caterpillar, no longer produces their own engines as of 2009 (Vertical Integration, 2014). Caterpillar now obtains the engines for their machines from a company called Perkins (Perkins, n.d.). The industry is showing signs of backward integration, indicating the industry has power in the market.
Pull Through
Brand identity of buyers
There are many companies in the industry whose brand is easily recognizable. The logos of Caterpillar, John Deere, and Hitachi are identifiable to most. These companies have branded their products in a way that the population can distinguish them from one another easily. Seeing a machine produced by Caterpillar or Deere on a construction site gives a better impression than seeing an unpopular brand truck. The popularity of a brand has much to do with their reputation which can be built by bystanders viewing the machinery on these construction sites. This influences buyers to purchase equipment from these manufacturers. This type of advertising gives the industry a power advantage over buyers.
Price sensitivity
The price sensitivity of buyers of construction equipment is relatively high. The purchase of just one of the machines produced by the leaders in the industry requires significant capital. A new excavator made by Caterpillar can cost approximately $100,000 to $850,000 (cost owl, n.d.). Komatsu’s excavators have a similar price range to Caterpillar.
Price to total purchases
Conclusion
Rivalry
The construction equipment industry is somewhat competitive. There are many big players in the game, each offering the same, or similar, products to their consumers. There are many factors that contribute to the rivalry of companies within an industry. The degree of concentration, the industry growth rate, and product differentiation are just a few examples of characteristics, among many others, to be examined to determine the level of rivalry within an industry.
Degree of Concentration
According to KHL’s annual Yellow Table ranking, U.S. company, Caterpillar, has ranked number one in the industry for the past fourteen years; controlling 18.1% of the market share. Japanese company, Komatsu, has trailed directly behind Caterpillar in the number two ranking for the entire fourteen-year duration. Komatsu controls 10.5% of the market share (Auctioneers, R.B., n.d.). Since these two entities have controlling power within 10% of each other, the industry is balanced. Following in the rankings behind Caterpillar and Komatsu, are Terex, Hitachi, and Liebherr, controlling 4.9%, 4.9%, and 4.7% of the market respectively (KHL Group, n.d.).
As the total of the five top companies in the industry equals 43.1%, the degree of concentration is fairly low. The industry is considered to be fragmented. In other words, the industry is unable to be influenced by a single corporation as there is not a company that possesses enough of the market share to control its competitors. With all outfits on an equal playing field, the industry is rivalrous.
Diversity among competitors
The top two companies in the industry, Caterpillar and Komatsu, primarily produce the same products. Of seventeen products listed on the KHL Yellow Table, these two entities produce ten of the same types of machinery, and neither produce three types of the machinery listed. The remaining companies in the industry produce a variety of machines as well. Excavators, telescopic handlers, wheeled loaders and ADT’s are produced by the majority of the top ranking construction companies, while only some produce machines such as cranes or dozers (Equipment, 2016). Rivalry among these companies is increased by the production of the same products.
Industry Growth Rate
In 2015, the revenues of the construction industry decreased 16.2% which is the equivalent of $133 billion. “This was the lowest revenues have been since 2009, when industry sales feel to US$ 109 billion at the depths of the global financial crisis, and it is also the sharpest year-on-year fall in revenues since those dark days” (Equipment, 2016). Despite this drastic decline in revenues, it is predicted that future revenues will only increase in the years ahead. According to Allied Market Research, the construction equipment industry is expected to reach revenues of $288.8 billion by 2022. This growth is equivalent to a 9.2% compounded annual growth rate (CAGR) (Budhiraja, A., n.d.).
The inflation rate in the United States reached 2.07% in 2016 (Inflation, n.d.). With a growth rate of 9.2%, each entity in the industry is able to grow without compromising the growth of another. Since all companies are able to grow, the degree of rivalry among these entities are reduced.
Fixed costs to value added
There are many fixed costs involved in the production of construction machinery. As with any manufacturing company, there are costs of business that cannot be avoided. Rent or a mortgage on a building can be very costly given the size of space required to build and store such large machines. Insurance costs can also be very high for both the assets and workers within the facility. According to Forbes, Caterpillar reported 105,700 employees in 2016 (Caterpillar Forbes, n.d.), Komatsu reported 47,208 employees in 2016 (Komatsu Forbes, n.d.), and Hitachi reported 320,725 employees in 2016 (Hitachi Forbes, n.d.). The magnitude of these operations are so great that the fixed salary costs associated with the number of employees each entity employs is also high.
The value added for this industry is low as the products of the various manufacturers are relatively similar. Companies such as Caterpillar and Komatsu don’t need to have high value added as their names speak for themselves. They can sell their products without spending a lot of time or funds on setting their products apart from the rest.
The industry is in the mature state of its lifecycle. We can draw this conclusion as the fixed costs are high, while the added value is low. This also proves the industry to be rivalrous, and unattractive.
Intermittent overcapacity
Capacity utilization is an important tool in the analysis of an industry. “The capacity utilization rate measures the proportion of potential economic output that is actually realized. Displayed as a percentage, capacity utilization levels give insight into the overall slack that is in the economy or a firm at a given point in time” (Capacity, 2016). The reports from the third quarter 2016 were published by The United States Census Bureau, indicating that the construction machinery manufacturing industry was running at a capacity utilization rate of 44.6% (Survey, 2016).
An industry ideally should operate between 80% and 85% capacity utilization. The construction equipment industry is running well below the normal range, indicating the industry has room to increase production and therefore revenues. An industry with a low capacity utilization rate contains companies that rival each other to increase, or at the very least, maintain profitability.
Product differentiation
There isn’t a large product differentiation among the companies in the construction equipment industry, which increases rivalry among these entities. Each company generally produces the same types of machinery. According to KHL’s Yellow Table report, the majority of the top competitors in the industry produce mini to mid-size excavators, capable of holding up to 13 tons in its bucket. Every company ranked in the top 10 construction companies produces an excavator capable of holding over 13 tons, as well as wheeled loaders. ADT’s and skid steer loaders are also included in the lineup of products many the top 10 companies in the industry produce (Equipment, 2016). The lack of variation in products that creates rivalry, makes the industry unattractive.
Growth of foreign competition
Foreign entities have already penetrated the U.S. market and have done so for years. Two of the top five construction companies in the industry in 2016 are Japanese companies, and a third is German. Japanese company Komatsu has been ranked number two for over a decade internationally. Hitachi, also a Japanese company moved down the ranks in 2016 to rank number 4. In the previous year, Hitachi was ranked number 3. Hitachi’s decrease in revenues made way for U.S. company Terex to move two spots up the ranks from number five in 2015 to number 3 in 2016. Many of the companies listed in the top ten were ranked in the top ten the year prior as well. The growth in foreign firm penetration has not grown but the companies do tend to move up and down the ranks from year to year. As of 2016’s report, the U.S. held 3 of the top 10 rankings internationally.
Corporate stakes
Companies such as Caterpillar, Terex, and Hitachi, among others, produce many varieties of equipment. Although they may be most popular for their construction equipment, these companies also produce equipment that is used in the mining and forestry industries to name a few. In addition to the production of heavy machinery, Caterpillar also provides financial services to those who qualify, competing with other lenders such as GE Capital Corporation and Wells Fargo Equipment Finance, Inc. John Deere also provides financial services under the name of Deere Credit Services Inc. (Caterpillar Financial, n.d.).
Exit barriers
The exit barriers of the construction equipment industry are low, indicating it is simple to leave the industry. This decreases the rivalry among the companies within the industry. Exit barriers are low when assets are difficult to sell or transfer, or when the possibility of merging is low. With so many companies in the industry, there is ample opportunity for mergers and acquisitions. Even if the entity itself isn’t being purchased, the assets of the entity can be sold to other companies within the industry.
Conclusion
Research shows that the industry of construction equipment manufacturing is one with significant rivalry. Nine characteristics of the companies within the industry were examined. The results of this examination concluded that this industry has more indications of rivalry than not. It was found that rivalry exists as a result of the degree of concentration in the industry, diversity among competitors, fixed costs to value added, intermittent overcapacity, product differentiation, and lastly, corporate stakes. Although the industry doesn’t provide high rivalry in the areas of industry growth rate, growth of foreign competition, or exit barriers, it is predominantly an unattractive industry.
References
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