23 June 2014

Digitalisation – new opportunities in old industries?

Unless you are Homer Simpson it’s unlikely that you’ve ever been beaten to a Worker of the Week award by an inanimate carbon rod. Or worse again, had an inanimate carbon rod steal all the glory for saving the space shuttle.

But as we transition from the analog to digital world, physical objects like an inanimate carbon rod may one day become more valuable; capable of transmitting informative data that can be analysed for any number of purposes.

While we all recognise the significant role the large internet giants play in our day-to-day lives, the ability to focus on information content will provide a distinct edge for the many industries that can benefit from the shift to digital technology.

Power by the hour

Take the asset heavy aerospace industry as an example of how engine manufacturers use data as a competitive advantage. In turn, engine economics have shifted from ‘Time & Maintenance’ contracts to ‘Rates per Hour’. This shift (identified in the table below) is clearly driven by engine sensors and the value of the information they transmit.

Time & Maintenance Rates Per Hour
  • Historically engines sold at cost or small loss
  • Targeted servicing to recoup revenue; 5 – 7 year cycle
  • Cost of large engine overhaul circa US $5mn
  • Margins for spare parts most lucrative
  • Fragmented aftermarket; manufacturers not getting full market Rates Per Hour
  • Shift facilitated by technology
  • Sensors monitor engine performance and transmit data
  • Contracts established at point of sale
  • Hourly rate est. US$300, paid monthly or quarterly
  • Engine overhaul included in contract ‘free of charge’
  • Shift facilitated by technology
  • Sensors monitor engine performance and transmit data
  • Contracts established at point of sale
  • Hourly rate est. US$300, paid monthly or quarterly
  • Engine overhaul included in contract ‘free of charge’

Flying high

The most important thing that translates out of all of this is the financial benefits experienced by both airline companies and engine manufacturers. Airline companies benefit from more reliable and efficient planes (think preventative maintenance, fuel consumption, and more hours in the air). They also gain greater visibility on otherwise large and lumpy maintenance costs under the old Time and Maintenance model.

The engine manufacturers benefit from cash flows that commence at the point of sale. And by gaining a higher market share in the aftermarket, margins are also projected to increase significantly through to 2020 using Rates per Hour contracts.

A higher plane

The technology shift driving efficiency in business models is a source of wealth creation and presents numerous opportunities. Businesses that can adapt are the ones that will stand to benefit from more effective R&D, higher productivity and the ability to build deeper customer loyalty. The potential to form long term partnerships and new ecosystems further creates barriers and can reinforce higher market shares.

In so far as equities are concerned, it’s therefore apt to finish with a meme inspired by the same Simpson’s episode – “I, for one, welcome our new technology overlords…”

For more information, Nick Bratt and the team at Lazard Asset Management, who manage the Zurich Investments Global Thematic Share Fund, know a thing or two about the global themes playing out in the market. In this video, Nick shares his views on the changing global framework as the world shifts from analog to digital. This is an extraordinarily important development – possibly more so than the original industrial revolution. Find out what this means for identifying winners of the future.

Important information: The content of this publication are the opinions of the writer and is intended as general information only which does not take into account the personal investment objectives, financial situation or needs of any person. It is dated June 2014, is given in good faith and is derived from sources believed to be accurate as at this date, which may be subject to change. It should not be considered to be a comprehensive statement on any matter and should not be relied on as such. Neither Zurich Australia Limited ABN 92 000 010 195 AFSL 232510, nor Zurich Investment Management Limited ABN 56 063 278 400 AFSL 232511 of 5 Blue Street North Sydney NSW 2060, nor any of its related entities, employees or directors (Zurich) give any warranty of reliability or accuracy nor accept any responsibility arising in any way including by reason of negligence for errors and omissions. Zurich recommends investors seek advice from appropriately qualified financial advisers. Zurich and its related entities receive remuneration such as fees, charges and premiums for the financial products which they issue. Details of these payments can be found in the relevant fund Product Disclosure Statement. No part of this document may be reproduced without prior written permission from Zurich.
Past performance is not reliable indicator of future performance.

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