Industry Trends

1. IndustryTrends

2. Our world is changing at an unprecedented pace. Each year, Strategy& looks at the major trends shaping different industries to help you navigate the challenges and seize opportunities.

3. 2017 Aerospace and Defense Trends • After decades of being the big players in a global pond, defense contractors must reinvent themselves as local businesses around the world. • Military budgets continue to tighten in the traditional big markets. Emerging nations seek to protect themselves and their growing economies. Thus defense contractors — most of which have roots in the United States or Western Europe — are looking in new places for customers. Instead of, for example, familiar territory like the North Atlantic Treaty Organization (NATO) allies, the growth arena for weapons manufacturers is mostly in places such as Saudi Arabia, India, South Korea, and Japan. This shift, in turn, requires landmark changes in the way defense companies approach new business and manage their customer relationships.

4. 2017 Automotive Trends • The future will be rocky for auto companies unable to improve returns on capital. • The global auto industry is more challenged than many people realize. On the surface, performance is strong. Worldwide sales reached a record 88 million autos in 2016, up 4.8 percent from a year earlier, and profit margins for suppliers and auto makers (also known as original equipment manufacturers, or OEMs) are at a 10-year high. Nonetheless, viewed through the lens of two critical performance indicators, the industry is in serious trouble.

5. 2017 ChemicalsTrends • Chemicals companies face a formidable challenge: delivering profitable growth in a hypercompetitive, low-growth world. • The structural headwinds in the chemicals industry are blowing like a gale out of the global economy. In a funk since peaking in 2007, global economies have been unable to reach the 35-year GDP growth average of 3.5 percent in six of the past eight years. And the two years of “high” growth were more of a bounce back from the sharp downturn of 2009 than precursors of a sustained turnaround. • Within this problematic macroeconomic environment, made worse for many multinationals by the strong dollar, demand for chemicals has fallen. Overall industry sales growth increased an anemic 2.1 percent in 2016 as the sector faced declining industrial production and broad inventory rightsizing by many of its customers. Chemicals companies that sell petroleum-based products often fell short of these industry averages because lower oil prices led to sharp top-line declines, sometimes in the range of 30 to 40 percent. Only naphtha-based producers benefited from oil price weakness, because it translated into materials cost reductions of about 60 percent for some companies, which greatly improved profit margins.

6. 2017 Commercial AviationTrends • The good news may be in the past, and now is the time for airlines to digitize and reassess their competitive positions. • What a difference a couple of years can make. In 2013, Warren Buffett called the commercial aviation industry a “death trap for investors.” In 2016, the legendary value investor spent more than US$1.3 billion buying the stock of four major U.S. commercial carriers: American Airlines, Delta, United Continental, and Southwest Airlines — and he has recently upped his stake to more than $8 billion. • Notwithstanding the speculation that this action is a precursor to Buffett’s company, Berkshire Hathaway, taking one of these major carriers private, Buffett seems to be betting that consolidation will continue to pay off for the airlines. He may or may not be right, but it is undeniable that airlines in the U.S. and in most other regions are enjoying a run of good results, buoyed by steadily rising demand and an extended drop in fuel costs. Industry-wide passenger traffic grew by 6.3 percent in 2016. And according to the latest International Air Transport Association (IATA) figures, commercial airlines posted their strongest financial performance ever in 2016 — reporting $35.6 billion in net profit, just a bit above 2015 results but nearly double those of 2014. For the third consecutive year (and only the third year in airline industry history), carriers reported a positive return on invested capital.

7. 2017 Commercial TransportationTrends • As digital native competitors proliferate, established transportation companies must embrace new technologies and offer new services to keep up with their customers.

8. 2017 Consumer Packaged Goods Trends • CPG firms that view cost cutting as the only strategic choice for profit growth may be making a mistake. • The changes roiling the consumer packaged goods (CPG) industry are significant enough that companies will have to reexamine fundamental tenets that have in the past served them well. Consider CPG revenue opportunities. Historically, population growth and gains in consumer spending provided reliable fuel for CPG expansion. That has changed. The number of consumers in developed countries has either flatlined or fallen; birth rates in North America and Western Europe are below the replacement rate. • Moreover, the majority of consumers in mature markets have, until 2016, endured more than a decade of stagnant wages, and members of today’s younger generation are at risk of ending up poorer than their parents. Those factors have combined to slow consumer spending. And in many emerging markets, such as Brazil, Russia, and China — where there is potentially a large market of new consumers counted on by CPG firms for future expansion — slowing GDP growth and currency weakness (sometimes mixed with high interest rates) have for now dampened consumer enthusiasm.

9. At the same time, consumer needs and habits are shifting, and CPG firms can no longer make the same assumptions about mass-market shopping activity. They could once rely on a large, relatively homogeneous group of middle-class consumers who would purchase staples and even a luxury or two at mid-priced stores, cognizant of cost but not overly concerned about it and seeking a modicum of quality for their money. • But in both the U.S. and the U.K., this uncomplicated consumer market has fragmented into two camps: survivalists and selectionists. Survivalists are cutting back and looking for value. Members of this group, which includes a vast and growing number of retirees and, in the U.S., millennials saddled with college debt, are stretching their budgets by limiting themselves to value retailers such as Aldi, Lidl, and Costco as well as online outlets offering lower prices and greater convenience. By contrast, selectionists can afford to be choosy and “select” for products they perceive as being of much higher quality. CPG companies offering premium-price items have made inroads with this group through namesake stores that reflect the qualities of their products. The unorthodox Lush cosmetics outlets, offering a panoply of scents, massages, and customized shopping, are a good example. Similarly, stores managed by Godiva chocolates, Apple, and athletics gear provider Lululemon deliver their own versions of the personalized experience for a select crowd.

10. 2017 Engineering and Construction Trends • Technology is changing the industry in ways that favor big firms. • Companies in the engineering and construction (E&C) industry have had few safe havens during the past several years. In the oil and gas sector, persistently low oil prices hindered — or stopped — work on most large energy projects. Even though prices have slowly begun to recover, most oil giants are still cautious about new initiatives with major capital expenditures.

11. 2017 Entertainment and Media Trends • Making businesses “fan”-centric requires functional transformation. • “The world is a dangerous place, Elliot. Not because of those who do evil, but because of those who look on and do nothing.” • Fans of NBCUniversal’sMr. Robot, a dystopian video series about hacker culture on the USA Network, will recognize this chilling call to action from Mr. Robot himself, played by Christian Slater. Decisive action is precisely what NBCUniversal took to forge a passionate following of tech-savvy millennial viewers for this show. It is now moving into its third season and has helped redefine the USA Network — once known for lighter, “blue-sky” content — as a network with an edgier, more complex sensibility.

12. To promote Mr. Robot, NBCUniversal recognized it needed a new playbook for audience development that went well beyond linear TV. The team created original content for Facebook Live, Reddit, Snapchat, YouTube, and Twitch, Amazon’s platform for gamers. The network also developed a virtual reality simulcast for San Diego Comic-Con 2016, and created a Mr. Robot experience in a Manhattan storefront where visitors could “hack” an Evil Corp ATM machine. What did these efforts have in common? They all encouraged Mr. Robot viewers to stay connected with storylines and characters in the environments where viewers desired that emotional and social connectivity. These experiences thus turned viewers into fans, and fans into zealots. • An entertainment and media (E&M) offering today simply cannot thrive without the economic, social, and emotional power of fans. Devoted followers are as critical to feature films, video games, and sports teams as they are to Mr. Robot. Premium content is expensive, and getting more so. Distribution is a brutal battle for shelf space where only brands that are “most wanted” can hope to win. The steady march of digital technology has ushered in a direct-to-consumer environment characterized by greater choice and user control. There is simply too much competition for users to allow E&M businesses to survive on experiences that cater to casual “eyeballs” or infrequent users.

13. 2017 Financial Services Trends • The days of old-fashioned centralized IT departments are numbered. • The rise of digital technology has dramatically altered the landscape in the financial-services sector. Banks offer financial planning and trading applications through smartphones and social media; cloud technologies are widely accepted, and in many cases robotics are already reducing cost and increasing quality. Since 2011, the number of startups in fintech (technology-based companies that often compete against traditional financial-services, or FS, firms) has risen more than 50 percent.

14. All this activity has provided new opportunities (and new competitive threats) for the industry. There is thus a significantly higher premium on the performance of the IT teams in FS institutions. To meet the demands of the new marketplace — to offer competitive, feature-laden, well-designed digital products and services, with a much faster speed-to-market, while lowering costs and continuing to support legacy systems — an IT function has to be flexible, efficient, and responsive. But those adjectives are not always applied to conventional IT departments. Many financial-services firms will have to do much more than merely reexamine their go-to-market strategies; they must also dispassionately reassess their IT operating model, and be prepared to jettison the approaches they have used for decades.

15. 2017 IndustrialManufacturingTrends • To take advantage of digitization, industrial manufacturers need new operating models, aggressive hiring, smart partnerships, and targeted investments. • Industrial manufacturers inhabit a world littered with uneasiness. Global demand for manufactured products is growing at a snail’s pace. Output is expected to increase just 3.1 percent in 2016 and 3.4 percent in 2017, according to the International Monetary Fund. Growth is dampened by Brexit concerns and political uncertainties. Foreign trade is at historically low levels, and, although oil prices have recovered a bit recently, they are not rising enough to undo the collapse in drilling and concomitant retraction in the rest of the energy supply chain.

16. 2017 Oil and Gas Trends • How energy companies can adjust their business models to a period of recovery. • The character of Chuck Noland, played by Tom Hanks, says near the end of the film Cast Away, “...because tomorrow the sun will rise. Who knows what the tide could bring?” He makes this observation after having survived on a desert island for four years before being rescued and returned to civilization. If you’re a top executive in an oil and gas company, more than likely you’re feeling the same way right about now — optimistic but extremely cautious. • Much of the oil and gas industry has survived an especially tough few years with weak demand and low prices. It has been difficult to make strategic decisions and plan for the future. Only now is the sector beginning to emerge from its upheaval. If there is hope on the horizon, we must, like Noland in Cast Away, remain mindful of the risk.

17. 2017 Pharmaceuticals andeLifSciences Trends • The New Health Economy is inspiring fresh ways to manage data, place a value on medical treatments, and deal with empowered patients. • Pharmaceuticals and life sciences companies are experiencing a wave of competing challenges as part of what could be called the New Health Economy. They include consolidation among providers, especially hospitals, intended to produce efficiency gains; the changing demands and expectations of patients, who seek a greater role in their own care; increasing cost pressures from payors leading to calls for pricing reform; and the declining autonomy of the individual physician as rule-based, protocol-driven care becomes ascendant. The resulting healthcare system will focus increasingly on paying for the value rather than the volume of medical care; in other words, it will be a more consumer-facing industry.

18. Pharma companies have always interacted with consumers. They have marketed directly to users, especially in the U.S., and they involve patients in clinical trials. They thus have some limited experience with consumer-facing business models. But the industry’s traditional means of engagement will no longer be sufficient. • In this new era, pharma companies will have to become more proactive with large communities of patients and go beyond lip service in meeting the needs of a wide swath of consumers. Although the sale of products will always be a priority, in the New Health Economy, pharma companies will also have to concentrate on delivering positive results: health, well-being, and optimal management of illness among targeted populations.

19. 2017 Power and Utilities Trends • The industry faces a complex challenge: managing a revenue downturn while meeting the demands of its technology-conscious consumers. • Everywhere in the industrialized world, the electric power and utilities sector finds itself pulled to economize and pushed to innovate — two goals that might seem to conflict, but that are actually in harmony. The pull comes from a prolonged downturn in consumer energy revenue on both sides of the Atlantic. End-use electricity consumption declined in 22 out of 28 E.U. countries between 2005 and 2014, according to Eurostat. In the U.S., the Energy Information Administration (EIA) reports that the electricity sales growth rate since 2002 has hovered around 1 percent or less per year, and demand has declined in five of those years. That’s a steep drop from growth rates that were well above 2 percent for much of the 1980s and 1990s. The rise in demand for electricity has been consistently lower than general economic growth in recent years.

20. Revenue growth is almost certain to continue slowing, and, according to the EIA, there may be two more years of decline during the next decade. This outlook reflects clear macro-level trends. The EIA cited a range of causes for the downturn: “Older equipment was replaced with newer, more efficient stock, [and] efficiency standards were implemented and technology change occurred, particularly in lighting and other appliances. The demographic and economic factors driving this trend included slowing population growth and a shifting economy toward less energy-intensive industries.” • Offsetting these trends, however, is a surge in demand for new power and utilities offerings — a surge so strong that the industry hasn’t yet caught up to it. Innovations in power-sector technology, such as new storage battery options and smartphone-based thermostat apps, are advancing at a pace that has surprised developers and adopters alike. Customers are asking for these products. To meet that demand, industry leaders are integrating those innovations into their operations and infrastructure as rapidly as they can. • If your company is in the power and utilities sector, the challenge you face is to close the demand gap and provide value for customers profitably. Do so, and you can expect a future of growth and customer loyalty. Fail, and you may risk being eclipsed by upstart competitors.

21. 2017 RetailTrends • For some retail sectors, showrooms may provide an attractive combination of consumer experience and compelling economics. • Ever since Amazon began selling books online in 1995, retailers — and plenty of other commentators — have been asking what role, if any, physical stores might play in the retail arena. Some have gone so far as to predict the ultimate demise of stores, and others expound the virtues of various hybrid omnichannel solutions. • To be sure, the trends are not good for store-based retailers, which generally complain of challenging conditions and frugal consumers. Although overall retail sales performance is quite strong, during the last several years essentially all of the inflation-adjusted gains in retailer revenue have been driven by online channels, which enjoy growth rates as much as 7 percent higher than retail sector growth as a whole (see Exhibit 1). Meanwhile, traditional retailers are faced with flat or declining sales and large, costly store networks

22. 2017 TechnologyTrends • The haves are breaking away from the have-nots. • The trends and innovations that will shape the technology industry over the next several years came into sharper focus in 2016. Cloud computing has gone mainstream for many enterprises, and the Internet of Things (IoT) is changing how both industrial and consumer-oriented companies do business. Drones and autonomous vehicles, blockchain, augmented and virtual reality, increasingly sophisticated digital assistants, machine learning (artificial intelligence, or AI) — the list of technological megatrends just keeps growing.

23. 2017 TelecommunicationsTrends • Aspiring to digital simplicity and clarity in strategic identity. • Senior executives at telecommunications companies around the world have heard for several years that their industry is approaching a tipping point. When it hits, they are told, their business might not survive the disruption. And yet they continue to do business. They might well think the warning from telecom industry specialists (including us) is overblown. Telecom customers are often locked into a long-term plan; many are loyal to their carrier. Doesn’t this suggest that the industry will continue as it is for some time? • To be sure, business upheaval often happens more slowly than people expect, and no one can predict exactly when the moment of truth will strike for any given company. But to judge from several trends that have roiled the telecom sector during the past few years, the time for preparation is over. You must now pick the businesses where you have a competitive edge and focus your strategy on them. Even if you think your current business model has several years of life left, you can’t be sure — and strategic focus will help you, no matter how far away the time of change.

24. How have we come to the conclusion that the tipping point is close enough to warrant change? By observing the state of the industry today. To a large extent, telecom companies have not succeeded in their efforts to monetize the flood of data running through their networks. Their services have become more commoditized. Their ability to reinvest in network upgrades and digital advances has been severely constrained. At the same time, many carriers have tried to be all things to all people, delivering a wide variety of services to their customers. But as a group, they have not managed to excel at any of those services. So now they are vulnerable to competition.