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HVC Technologies is a large machine-tool manufacturer in the business of manufacturing lasers and coatings equipment. It has a broad, international focus with production sites throughout the world. While HVC’s lasers are used to produce a new machine component, coatings machines are used to spray a thin film of material onto existing components in order to boost the component’s durability. When HVC was initially founded, it decided to focus on these two technologies because they were related to machine components. Since then, however, the technologies have diverged considerably and there are limited synergies between the two.
The key facts about HVC’s lasers business are as follows. HVC has approximately 25% of its business in lasers, and a 5% share of the overall market, which is a fast-growing and high-margin business that is expected to grow by 20% on average over the next five years. Most of this growth, however, is in market segments where HVC is not represented. HVC focuses on high margin, customized lasers while the industry’s growth is primarily in the growing use of standardized lasers, which have lower, although still attractive, margins. HVC has recently considered making incremental investments to extend the product portfolio of its laser business to include product lines in the high-growth segments of the market. That would position HVC as a full-range supplier of lasers, and enable it to take advantage of the industry’s strong growth. As HVC is the market leader in terms of quality and innovation, the firm believes that even though standardized machines are a commodity product, it could still realize a superior return on sales of standardized products by exploiting the reputation it has achieved with customized lasers. HVC, however, has not yet made a decision about this alternative because it would require a considerable financial investment in the lasers business and would divert resources from its coatings business.
The key facts about HVC’s coatings business are as follows. HVC has about 75% of its business in coatings. The business consists of two aspects: manufacturing coatings machines and providing coatings services. The manufacture of coatings machines is a capital-intensive business with high margins and minimal growth. HVC is one of the market leaders in this oligopolistic industry, and has a 30% market share. The market is expected to stagnate over the next five years. HVC’s business with coatings services involves rendering coatings services to customers using the coatings equipment it manufactures. This activity, which is quite small, is a fast-growing business in a highly-fragmented, regional market. The market is expected to grow by 20% annually over the next five years and realize operating margins of 30% on average. There are no significant global companies providing coatings services. The providers are generally regional companies that work on an outsourcing basis. Many customers of coatings services have decided coatings technology is too specialized to master on an ongoing basis. In addition, the technology is new, so it is unclear whether its use will be more widely adapted over the long term. Outsourcing, therefore, is the preferred approach for new customers. Besides the cost of the machine, the expense to actually render the coatings service is low and the expertise needed to manage the process is limited. The main value-add for the customer is to configure the coatings material to achieve the customer’s requirements. This value-added activity takes a long time to realize and requires significant up-front investments in research and development, making it a highly-specialized activity. HVC, however, has developed this expertise due to its core competence in manufacturing coatings machines. This distinguishes it from other coatings services providers that buy the material from the customer, and has thus enabled HVC to realize a gross profit on coatings services of 40%, far more than the industry average.
HVC’s CEO is working with the Board of Directors and senior leadership team to reevaluate and update the company’s strategic plan. HVC’s stock price has languished for several years and has underperformed its peers during this time. The board wants the CEO to submit proposals for the company’s strategy. To that end, the CEO has commissioned a market research firm to analyze the future growth potential and profitability of HVC’s markets. Exhibits 1 and 2 summarize the outcome. HVC has largely exhausted its sources of external financing, so its strategy going forward must rely on internally generated funding. The company must make some hard decisions about its existing businesses in the new strategic plan.
Exhibit 1: Financial forecasts (figures in US$ million)
Figures in USD million | | Prior year | Current year | Current year +1 | Current year +2 | Current year +3 |
|---|
| LASERS MANUFACTURING | Revenue | 248,000 | 250,000 | 255,000 | 260,000 | 265,000 |
| Operating profit (EBIT) | 24,400 | 25,000 | 25,500 | 26,000 | 26,500 |
| COATINGS EQUIPMENT MANUFACTURING | Revenue | 720,000 | 726,000 | 732,000 | 739,000 | 745,000 |
| Operating profit (EBIT) | 71,000 | 72,800 | 73,600 | 73,700 | 74,500 |
| COATINGS SERVICES FOR THIRD PARTIES | Revenue | 10,000 | 24,000 | 60,000 | 100,000 | 150,000 |
| Operating profit (EBIT) | 3,000 | 6,600 | 15,000 | 26,000 | 43,000 |
| TOTAL COMPANY | Revenue | 978,000 | 1,000,000 | 1,047,000 | 1,099,000 | 1,160,000 |
| Operating profit (EBIT) | 98,400 | 104,400 | 114,100 | 125,700 | 144,000 |
Exhibit 2: Forecasted product-line gross margins
Product line gross margins | Prior year | Current year | Current year +1 | Current year +2 | Current year +3 |
|---|
| Laser business - HVC's current product line | 30% | 30% | 30% | 30% | 30% |
| Laser business - Standardized products | 16% | 17% | 18% | 19% | 20% |
| Coating business - machine manufacture | 30% | 30% | 30% | 30% | 30% |
| Coating business - coatings services | 40% | 40% | 40% | 40% | 40% |
