Blog

There has been a lot of recent discussion about the Australian economy and its performance on the global landscape. There is no doubt that Australia has been “the lucky country” in comparison to other developed countries. But the question is how well is the Australian economy geared for future growth and what initiatives should business leaders consider to position Australia for the challenges and opportunities that lie ahead?

Thirty of Australia’s CEOs and business leaders from major companies across a range of industries were surveyed and asked to respond to this question. The survey targeted executives from retail, mining, banking, leisure and entertainment, high-tech, communication, manufacturing, agriculture and finance.

Each executive was asked to identify from a list of 40 possible options the key business initiatives that they believe would assist Australia’s economic growth and prosperity by 2015.

The survey results produced the following list of 10 key initiatives:

• Labour market legislation
• Sourcing labour talent
• Education and vocational training
• Robust corporate risk strategy
• Developing infrastructure to attract Asian investment
• Increased depth of business knowledge of Asia’s markets
• Development of rail and road infrastructure
• Investment in digital infrastructure
• Segmentation of products for different markets
• Innovation planning for business and products.

The findings highlighted key trends with 82% of executives in agreement that Australia requires short-term legislative change in industrial relations. There was a consensus that high labour costs and restricted labour flexibility were impacting on productivity, and that labour market regulation needs a thorough review. Improvements to the Fair Work Act, increased flexibility in the labour market, tax reform and limitations surrounding imported labour were all highlighted as barriers to business.

Additionally, an initiative for providing a mobile skilled labour pool with access to the right talent was considered a priority for many CEOs. The lack of trained management and skilled technical labour, particularly in more remote geographical areas in Australia, is seen to present a challenge and restrict growth opportunities for a large number of companies.

Most CEOs indicated that recruiting and training high-potential middle managers and building leadership teams with strong skills and competencies were critical for business growth. Management of talent, including retaining employees, was high on the agenda as talent shortages impact on profitability.

Executives highlighted the need to establish new initiatives to resource Australia’s educational systems so, in the longer term, labour is more capable of keeping pace with business needs. Two out of three senior executives said initiatives were needed to develop a labour market with more job‑specific skills. To achieve this, Australia needs to invest in more extensive vocational training and close the gap between education and employment.

A high proportion of executives believe that corporate strategy needs to remain robust and accommodate business risks if Australia is to avoid innovation and growth becoming stifled.

Risk appetite was highlighted as an important consideration by 74% of the surveyed executives who were concerned that the global share-market’s volatility and a slowdown in economic conditions were resulting in a conservative approach to corporate strategy.

One in three executives also commented that corporate risk strategy was an ongoing focus for many companies with the level of competitive intensity increasing across all industries, particularly as communications and technology broadened markets and digital media transformed business potential.

With Asia as an intrinsic economic trade partner in Australia’s future, 68% of executives proposed initiatives that involved investment and development with China, Indonesia, Vietnam, Thailand, India and other Asian markets. Given the proximity and development of Asia as the world’s largest producer and consumer of goods and services, executives said that resourcing and prioritising for planning and creating infrastructure to support this growth was a key requirement.

The majority of the executives surveyed acknowledged that the Asian market will increasingly demand a broad range of Australia’s goods and services, from education to consumer goods, banking and financial services, health, high-end food products and tourism. Some of the opportunities arising from Asia’s growing middle class are already evident.

A potential opportunity, cited by a CEO from a leading hospitality organisation, is Australia’s ability to attract China’s outward-bound tourist market. There is a need for national investment in luxury destination golf resorts and spas, six-star hotels, casinos and signature restaurants. The demand of Asia’s emerging middle class for luxury travel destinations will have an increasing impact on inward bound tourism, if the right leisure and hospitality infrastructure is developed to service this new market.

One in five executives said developing and training our business leaders with greater Asian literacy and a deeper knowledge and expertise at an executive board level is critical to Australia’s ability to operate efficiently within the Asia-Pacific region.

Development of rail and road infrastructure was among the key initiatives identified by 79% of executives. The opportunity to increase productivity and develop new markets is undermined by inefficient road and rail, and inadequate port facilities in particular.

The majority of goods produced and consumed in the Australian economy are transported at some stage in the production lifecycle. With Australia’s dispersed population and production centres, the efficiency of freight transport, and the efficiency of the infrastructure it uses, are central to the country’s economic performance.

Ensuring that Australia is well positioned as a leading digital economy by 2015 is a key initiative for 71% of executives. The National Broadband Network rollout will enhance digital commerce and productivity opportunities for Australian businesses. As the speed and capacity of the digital network expands, it will have an impact across a wide range of industries, resulting in significant savings on distribution costs and enabling many businesses to trade to a global market. This initiative was considered key to drive new business processes and innovations supporting Australia’s economic growth.

With the Australian economy rapidly evolving, 64% of executives believe there is a need for Australian business to adapt and modify product and services for market segmentation in both domestic and global markets. As market dynamics are constantly changing, the need to create products for markets to suit local customer preferences requires business to rethink existing strategies and reinvent solutions in response to customer needs.

Australian business needs to better understand initiatives involving customer segmentation by investing in R&D, using analytics and new developments in marketing practice and, when required, implementing new production and distribution processes to meet customer requirements.

A significant proportion of CEOs and executives also identified effective innovation planning as fundamental to building successful businesses in Australia, not only creating new product and services, but also reinventing core business offerings through the process of mergers and acquisitions, divestment, alliances and partnerships.

With rapidly changing technology, particularly through the internet, an intense level of business competitiveness and market globalisation, the impetus to innovate and deliver customer-based solutions is critical to business survival.

In summary, the survey results showed that business leaders want initiatives to achieve a better balance in the labour market, with progressive changes to legislation, immigration and tax reform that respond to current market challenges.

A high proportion of CEOs are concerned that our domestic policy continues to develop and support major infrastructure development to keep pace with business needs. Additionally, business leaders see opportunities for Australian business to continue to harness Asia’s growth and extend our investment in emerging markets. Innovating our business offering to deliver effective strategy, product and solutions based on changing customer needs is also seen as crucial.

The funds management industry is undergoing fundamental structural change, not just in Australia but also on a global basis. The key structural changes impacting at present include the move away from Australian equities into alternative investments, the in-sourcing of investment management capability by large funds, significant management fee reductions and the increasing competition in the industry from new fund managers and new products such as Exchange Traded Funds (ETFs).

These structural changes have come about due to the maturing of the funds industry, the crash in equity prices in 2007 and 2009, and the increased competition in the mid to large sized superannuation funds.

The industry has grown on the back of large increases in superannuation savings, high fees and inexperienced investors. As a result, large profits have been generated and, in turn, this has attracted new entrants into the industry.

At the same time, Funds have grown in size and are now in a position to exert significant power in the marketplace by actively demanding reduced fees from the funds management industry, building their own in-house management and also competing directly with fund managers with their own investment manager, Industry Funds Management (IFM).

Concurrent with these changes has been a lack of confidence by investors in both the share-market and fund managers, leading to substantial outflows from equities into ‘safe investments’ such as short-term deposits.

Main structural changes

One of the major impacts on the funds management industry currently is the cyclical and structural move away from equities, particularly Australian equities. Wholesale funds and retail investors have been overweight to equities and equity related investments and, as a result, have suffered poor performance since the global financial crises.

The realisation that many of the investments in multi-sector portfolios were highly correlated to equities has led to a move to reduce the core equity exposure and diversify into investments with lower correlations to core equities.

This has meant an increase in exposure to alternative investments including diversifying assets such as hedge funds, infrastructure, distressed debt, private equity, natural resources, gold and commodities, real estate, debt and equity emerging market, high yield and small cap equities strategies.

The Future Fund, the largest fund in Australia, has 6% invested in infrastructure and timberland and 6% in private equity. Alternatives in the Future Fund are mainly hedge funds with strategies such as multi-strategy, relative value, macro-directional, distressed event driven and commodity orientated.

Australian Super ($45 billion) has 18% in infrastructure and private equity and is looking to further increase its exposure to alternative assets in the future.

Most funds are diversifying their portfolios with funding coming primarily from a sell-down of the Australian equity weighting. Historically, the home bias has led to a high relative weighting in Australian equities. As a result of this down weighting, funds flow in Australian equities has been negative.

In the retail market the low returns and concerns of macro impacts have led to flows out of equity related products being parked mainly in cash and fixed income investments.

Another impact on managers of Australian equities is the move by the larger funds to take investment management in-house. A few of the larger funds have built or are building in-house management capability in an attempt to lower costs and gain more control over their investments.

It is recognised in the industry that once a fund’s size is $15 billion or more it becomes economical to start to replace external mangers. Australian Super ($45 billion) spent over $200 million in external management costs last year.

Industry funds are also competing against managers by setting up their own stand- alone manager, IFM. IFM now has $36 billion in funds under management and is owned by many of the industry funds, including smaller funds, and offers funds management across all investment sectors.

This is a very efficient way for the industry funds to control their investments. This development should not be dismissed, as the large retail funds have been very successful in implementing this strategy and have attracted high calibre investment talent to manage the business.

It is evident that in the future a large portion of the moneys managed in Australia will be handled in-house by these large wholesale and retail funds.

Funds are competing in the market by offering low cost products and have focused on reducing the costs associated with their products. This is unfolding in a number of ways.

Firstly, funds have become far more aggressive in negotiating fees with fund managers resulting in a significant lowering of fees for mandates. The funds are in a strong position to negotiate, as the funds management industry is highly competitive.

Secondly, they are changing the manager mix and risk profile within their Australian equity exposure. Funds are reducing their exposure to active managers and increasing their exposure to passive, lower cost investments.

One model that is getting attention is to have a 50% weighting to passive exposure and 50% to active, thereby reducing the fees/costs on half the portfolio but keeping exposure to the equity market.

The downside in this strategy is the reduced outperformance that can be generated via active management. To compensate for this, funds appoint more aggressive managers for the active component, increasing the potential to outperform and compensating for the fund’s 50% passive exposure.

The other main influence on costs and fees is the Gillard government’s MySuper initiative to introduce low cost funds to the superannuation market.

Under MySuper, super funds are required to offer a low cost balanced fund with fees much lower than those currently on offer. This is already having an impact on fees in the industry, with a retail fund already offering a no fee balanced fund.

While these structural changes are taking place the market remains intensely competitive in Australian equity products, particularly in the ‘core’ equities product offering where approximately 55 companies are vying for Australian equity mandates.

In addition there is increased competition in the market with new equity products that can be traded on the stock exchange. These Exchange Traded Funds (ETFs) have been popular internationally and are gaining favour in the Australian market.

The market for ETFs has grown by 25% in the last year and now totals $6 billion with 84 ETFs. This means that the funds management pie will continue to be cut into smaller pieces.

3D Printing – A brave new world

The development of 3D printing is changing the traditional perception of manufacturing. 3D printing or additive manufacturing is not a new concept and has been used in various industries for many years.

The inception of 3D printing began in 1976, when the inkjet printer was invented and subsequent changes and adaptations in the mid 1980’s allowed the technology to advance from printing with ink to printing with materials.

3D printing can now use a range of materials from metal such as titanium, plastics and even human cells and is able to produce any number of parts and components.

Sceptics of the adoption of 3D printing point to the high cost of material, the slow build, the limited detail capability of some printing techniques and the restricted adoption of the technology across industries.

However the scope and capabilities of 3D printing hardware have changed rapidly in the last few years. The technology is producing larger components with greater detail, precision and finer resolution.

As 3D printing emerges to become a viable alternative to traditional manufacturing processes, it creates an increasing number of potential applications across a growing number of industries.

Pacific Consulting Group has undertaken research examining the current use of 3D printing technology among early adopters in the Australian manufacturing industry. Our research shows that the use of 3D printing could become a likely alternative for manufacturers producing complex, low unit volume or single unit parts.

If this emerging trend continues, we estimate that 3D printing will profoundly transform manufacturing and significantly impact on business and the global economy within the decade.

Advances in 3D printing technology continue to provide greater flexibility in manufacturing processes. The benefits to manufacturing companies are significant with reduction in lead times, high levels of cost savings and overall improvement performance.

Research substantiates that its application is particularly relevant to those manufacturers where there is a high level of emission and waste, high labour cost and low unit volume production.

Direct manufacturing can now eliminate many manufacturing processes including sourcing individual parts, creating moulds to build parts, tooling parts and assembly.

By removing expensive and complex tooling costs along with high levels of labour costs associated with large assembly processes and limiting current handling and storage costs, we estimate that manufacturers can potentially reduce costs by up to 40% based on estimated investment and expenditures.

Our conversations with manufacturers that are using plastic moulding to produce products and parts suggest the application of 3D printing will continue to add value to the process by reducing the set up time and minimising tooling errors and waste.

One of the advantages of 3D printing is that prototypes in the industry can be developed for evaluating complex requirements within hours and design changes can be made easily by amending the source file and producing a new part for immediate testing.

With the change in focus to the design process and concept developers in a 3D environment, our research established that there has already been a departure among some companies away from the traditional manufacturing process, with less consultation at different stages along the supply chain.

Our research shows a greater amount of integration and coupling occurring in the initial concept development, with the emphasis now on how a product is designed, tested and modified.

It is anticipated that 3D printing will reverse the design for manufacturing process (DFM) to that of a manufacturing for design process, as software capability allows the developer to make simple design amendments and adaptations to streamline the end product.

Consumer Use and Application

A key driver of 3D printing in the next decade will come from consumer use and demand. The expected growth of the consumer market will most likely exceed the estimated growth in the commercial market.

Significant recent improvements in technology and expansion of channels for 3D printed products are likely to result in the printing of multiple new and existing manufactured goods.

With prices decreasing over recent years, 3D printers for domestic use start at as little as AU$2,000. Manufacturers of 3D printers are delivering improved quality with expanded global distribution. Many are leveraging the expiration of patents to produce lower priced printers targeting the consumer market. It is anticipated that worldwide shipments of 3D printers will double in 2015. Consumers will have access to affordable 3D printing by purchasing a printer for in-home use, through a 3D printing store or by ordering a 3D printed product online.

Eliminating the costs of distribution and reducing the costs of the design and marketing embedded in products, could make the potential savings of 3D printing more competitive than purchasing through retail. Aside from cost savings, consumers printing their own goods can also benefit from customising the product. A pair of trainers can be customised to fit perfectly. The cost of goods will be influenced by the cost of the material utilised for production, so items such as toys and other products made from plastics will be reasonably inexpensive.

It is likely that mass customisation of products will lead to a sharing of design ideas online and consumers will be able to access the design patterns of many manufactured products. This trend has already been established through practices such as crowdfunding.

Designers are starting to create and sell 3D printed products or even their designs direct to a consumer using online services such as imaterialise and Shapeways.

Manufacturers will need to consider how to diversify their business to accommodate new channels of distribution and direct competition from self-printing consumers and potentially cater to the emergence of a plethora of designers and entrepreneurs developing ideas and products. Our research suggests there will be a significant transition for many companies engaged in traditional manufacturing to becoming a virtual business, with a focus on selling intellectual property and idea generation to consumers rather than the end product.

Customisation of product also raises challenging questions about future copyright protection and the impact this will have on companies’ products and brands.

There are challenges ahead for policy makers when addressing regulatory issues, ensuring appropriate intellectual property protections, and approving new materials for use.

In evaluating and considering these challenges business and policy makers will need to address the risks and opportunities without restricting the potential and innovation that 3D technology can provide.

The impact of 3D printing on Australian business

It may be a few years before the technology constraints currently holding 3D printing are removed, but at that point Australia is likely to be deeply impacted by the disruptive force of 3D printing for a couple of reasons:

1.    The labour cost in the country is high. This has led to the offshoring of manufacturing and remaining local manufacturing is relatively expensive.
2.    The country is remote and it is large. As a consequence, international and domestic logistics costs are high, transit times are longer and therefore inventory levels must be higher due to the distances goods must invariably travel.
3.    As a developed nation with relatively high disposable income, the desire for customised goods will be higher than less developed nations.

The good news for large companies is that they can potentially make use of 3D printing to reduce supply chain costs. The risk for those companies is that a significant barrier to entry – the ability to manufacture or source manufacture – will be removed. This can increase competition.

Good designers or innovators will no longer need the support of large organisations in order to create or distribute their product. And with the advent of social media as a bona fide marketing tool, they don’t need the advertising budget the company traditionally provided access to either. Talent attraction and retention will become increasingly important.

Logistics companies themselves face an interesting trade-off: 3D printing may result in a material reduction in consignments as businesses simply print the needed component instead of shipping it. The benefit is that 3D printed products are mostly smaller, lightweight items generate very little revenue per item for the logistics company. Logistics companies could also opt to act as a 3^rdparty printer, investing in 3D printing hubs and incorporating it as a service offering for their clients that do not wish to invest in their own equipment.

The biggest change should be for the small Australian business, now not constrained by labour cost, with the ability to manufacture small, customised batches on demand with little to no cash tied up in inventory. The small business who can now have a delivery lead time equal to print time plus local courier time.

While the other benefactors of 3D printing potentially see new markets or perhaps reduced input costs, the small Australian designer / manufacturer 3D printing can create a viable business where one did not previously exist. And that can be disruptive for everyone else.

Are discounts used as a volume driver or to create a price anchor?

The goal is not to minimise discounts, the goal is to maximise net sales

Looking at the above graph, it is tempting to see customer discounts as the single biggest opportunity to improve contribution. Reducing the discount will increase the contribution. In reality, this conclusion is probably only partly correct.

The goal is to maximise net sales, not minimise discounts. The subtle difference in restating the goal in this way reveals two possible objectives for discounting:

• Discount to drive volume
• Use discounts to create a price anchor

What is a consumer willing to pay?

Studies in behavioural economics suggest that consumers do not necessarily understand the value of the things they purchase. Without understanding value, they look to other signals to determine how much should be paid.

This is why post-purchase rationalisations are made for expensive items: “It was 50% off, what a bargain!”

The discount of 50% is completely dependent on what the potentially inflated recommended retail price is. Value can be created in a situation where a consumer would rather pay $130 after 50% discount than $100 with no discount for the same fashion item. The $30 premium is paid for the perception of value.

If a retailer chooses to operate in this way, monitoring and reporting on the value of discounts granted is clearly a waste of time and drives behaviour that contradicts the discounting strategy.

In Australia, volume appears to be the primary objective

Our research reveals that the majority of large retailers tend to use discounting to drive volume.

If more volume is the goal, how much more volume is needed?

Why is volume the primary objective?

Retail results are studied closely by economists. Retail spending is an indicator of consumer spending. Consumer spending is the largest component of aggregate demand. It also is an indicator of consumer sentiment.

Immense pressure is put on retailers to match or better prior year sales.

However, while matching revenue may indicate stable consumer sentiment it does not necessarily help retail fashion shareholders through stable or improving profits.

In fact, it could be doing just the opposite.

Revenue is vanity, profit is sanity

Often, discounting is initiated to maintain sales levels when performance is poor compared to prior years.

The increase in sales volume required to maintain margin after discounting is much greater than the increase required to maintain sales.

Simply maintaining sales revenue through aggressive discounting can easily lead to a decline in margin if volume growth is insufficient.

If this process is repeated year after year and volumes are not increasing enough, there is a real chance of declining profit.

Evaluating the results of discounting strategies

If the primary purpose of discounting is to drive volume as opposed to engineering a higher eventual selling price per item, we would expect incremental discounts to drive incremental volume. To test this hypothesis, we need a way to measure customer responsiveness to changes in discounting.

Price elasticity of demand is technically correct but difficult in practice

The responsiveness of demand for a product relative to changes in price is referred to as price elasticity of demand and is expressed in formula form as:

% change in quantity demanded

% change in price

In economic theory, calculating the price elasticity of demand is simple. It is simple because it has few data points, it assumes informed buyers that respond reasonably and consistently to changes in price, it assumes that stock is available in the size required and there is consistent market for the product.

In order to evaluate effectiveness of discounting strategies, an alternate measure of responsiveness to price change is needed.

 

Considering quarterly correlation between discount and volume

Another way to evaluate how customers respond to discounting is to calculate the co-efficient of correlation between discounts granted and volumes sold. In order to account for seasonality, the time series evaluated can be broken into quarters.

The benefit of this approach is that it is easy to calculate and replicate across all fashion lines or SKUs. The output of the analysis is also fairly easy to understand and evaluate over a period of time.

Are discounting strategies effective?

When evaluating effectiveness of discounting, PCG follow a similar pattern for all our engagements that require detailed analysis.

We form high level hypotheses and then test these using enterprise data. We also evaluate the data across as many dimensions as possible in order uncover actionable, money-making insights.

We have noticed a number of trends in discounting strategies across a few retailers that indicate opportunity for improvement.

If strategies are effective, it is more likely by chance than by design

Discounting is largely a re-active process.

Reasons for discounting tend to fall into three categories:

1. Scheduled sale to coincide with holiday or event
2. Sale to match competitor
3. Sale to bump revenues to produce comparable result to prior year.

There needs to be more sniper rifle, less shotgun

The reactive nature creates a time constraint on creating a discount strategy. Lack of analytical resources creates a capability constraint on creating a discount strategy.

The end result is a broad brush discount strategy which is as likely to erode value as create it.

Instituting store wide discounts means that lines that sell well regardless of price are reduced as well.

These broad discounts also condition customers to wait for discounting before purchasing.

Using only averages can produce average results

Even when a level of analytical rigour is introduced in creating discounting strategy, profits may not be optimised.

Unless the analytics are done at a sufficiently granular level, value eroding decisions can still be made.

• Do all stores respond in the same way?
• Do geographies influence impact of discounting?
• Do colour and sizing have any bearing?

Discounting is not the only driver of volume, and it is not the cheapest either

In retailers with a loyal customer base and effective loyalty program, we notice than direct marketing campaigns can yield significant uplifts in sales. Marketing campaigns can yield exceptional returns on investment.as the cost of the inclusion of a single fashion item in the campaign is spread over every item sold. This as opposed to discounting where every item sold attracts incremental opportunity cost.

We noticed that retailers’ reporting systems to not provide adequate feedback on stock availability. The general consensus is that they have too much stock, but deeper analysis reveals that quite often certain sizes are not properly catered for resulting in lost sales.

How can PCG help?

PCG’s analytical strength and depth of experience in the retail business

PCG has invested heavily in its analytical capability, recruiting experienced senior analysts and forming a separate group, PCG Solutions, to tackle problems which require bespoke solution development.

PCG also has extensive experience in the retail industry and is able to guide businesses on discount strategy creation and implementation.

By performing in-depth analysis, we are able to answer tough questions like:

• Are certain SKUs responsive to discounting?
• Does responsiveness to discounting change according to season?
• Are sales spikes determined by other factors such as restocking or marketing campaigns?
• Are store-wide discounts being granted on lines that sell well irrespective of available discounts?
• Is the customer loyalty program creating value?
• How are stock levels managed by store?

Knowing the answers to these and similar questions allows the fashion retailer to make informed decisions around its discounting strategy.

Discounts can be planned in focused way to yield better results than simply applying store wide discounts.