Fast-Moving EV Battery Market: How to Win the Competition?

The global trend toward electric vehicles is taking place in China’s auto industry. Strong policy support and continual technical advances are the key drivers. For example, the U.S. government incentivizes EV purchases by providing a tax credit of up to $7,500. China has also set ambitious targets and introduced subsidy policies for new-energy vehicles, making China the world’s fastest-growing EV market.

The prospect of continued rapid growth in EV sales is beyond doubt. However, with changing subsidy policies and maturity of the market, competition will become increasingly intense. The American government is considering cutting the tax credit mentioned above, and that will have a significant impact on the EV market. In China, data shows that China’s overall subsidy on new energy vehicles in 2017 has dropped by 40% as compared with 2016, although EVs with high energy density and long battery life continue to receive support from the government. China will stop subsidizing pure EVs with battery life below 150 km but increase subsidies for models with longer battery life.

Under the policy changes, the fast-growing EV battery market is facing increasing challenges. Entry barriers are becoming higher and the market is consolidating. The number of EV battery manufacturers in China dropped from about 150 in 2016 to fewer than 100 in 2017.

So, what are the key success factors?

1. Investing in technologies: Follow the development of next-gen technologies

NiCoMn/ NiCoAl (NCM/NCA) batteries enjoy advantages in energy density and are catching up in cost.

Energy density: In China, policy guidelines require that the energy density of a passenger vehicle battery needs to reach 300Wh/kg by 2020 and 500Wh/kg by 2030. NCM/NCA batteries will be the only ones that can achieve this level of energy density.

Manufacturing cost: Increasing battery production brings economy of scale, with the cost of NCM/NCA batteries estimated to further decline over the next few years. Although the recent rise in the price of cobalt is a factor, it’s still highly possible that NCM/NCA batteries will break the threshold of 1,000 RMB/Kwh in two years.

Safety and service life: Both the safety and the service life of NCM/NCA batteries will be further improved with technical advances, such as better battery management and cooling systems. The number of full charging cycles for this type of battery will reach 1,200 (nearly a 15-year life) by 2020.

We project that global market demand for NCM/NCA batteries will increase rapidly.

In addition to NCM/NCA, a series of new technologies are emerging that will shape the market in the long run. For example, lithium-ion with solid electrolyte can greatly improve safety and energy density. The energy density of lithium-ion batteries with solid electrolyte can be 2.5 times greater than that of liquid electrolyte. Meanwhile, with the absence of liquid electrolyte, storage becomes easier, and additional cooling systems or electronic controls are not required, significantly enhancing safety.

Toyota announced significant progress in solid electrolyte battery research at the end of 2017 and plans to begin shipping cars with solid-state batteries in 2022. In China, several companies and research institutes have also begun research on solid electrolyte batteries. Contemporary Amperex Technology Co. Limited (CATL) and China Aviation Lithium Battery Co. (CALB) have announced that they are both accelerating the development and commercialization of solid-state batteries.

Lithium-ion batteries with solid electrolyte still have problems such as high manufacturing costs, insufficient solid interface stability and low electrolyte conductivity, although these problems will gradually be solved. We believe that early commercialization of solid-state batteries might occur by 2022, with gradual achievement of scale industrialization by 2025-2030.

2. Ramping up capacities: Accelerate capacity buildup and drive cost down through scale

Manufacturing capacity for EV lithium-ion batteries will expand rapidly to reach 180GWh globally by 2020. China will be the fastest-growing country in terms of capacity, with an estimated 60%-65% of share by 2020, surpassing that of the United States.

Low capacity and disadvantages in economy of scale will be the major challenges faced by small to midsize manufacturers.

Cuts in subsidies and pressure from downstream OEMs will squeeze the profit margin of battery manufacturers. Companies need to expand capacity to gain an edge on capacity and cost in order to survive. “Megafactories” with 20GWh capacity will bring significant competitive advantages.

Capacity expansion results in a reduction in manufacturing costs. Tesla claims that its newly built megafactory will lead to a 30% drop in battery cost. CATL achieved a 15% decrease in battery cost in the past two years through technology upgrades and capacity expansion.

Rapid expansion of capacity will bring about financial risks. Therefore, strategic partnerships with downstream OEMs are vital to risk reduction. The $5 billion joint venture between Panasonic and Tesla is the most well-known example of how EV battery manufacturers cooperate with OEMs to deal with competition and risks. Similarly in China, SAIC and DF Motor invested in CATL, and BYD announced cooperation with Guoxuan High-Tech. These are all considered to be forward-looking strategies.

3. Moving up the value chain: Control key technologies and resources through vertical integration

EV battery manufacturers (and some EV manufacturers) consider vertical integration as key to lowering costs, extracting more value through synergies both upstream and downstream, and avoiding commodity price/supply fluctuations.

Electrode materials

Given the growth in battery sales, demand for raw materials will increase rapidly, especially for nonferrous metals such as lithium, nickel and cobalt. Steady cobalt and nickel supplies are of critical importance.

  • Cobalt: Further promotion of NCM/NCA batteries will drive demand for cobalt, pushing up its price
  • Nickel: The trend toward “high nickel” will drive increasing demand for nickel sulfate; however, domestic pressure about environmental protection concerns may limit the supply capacity of nickel sulfate
  • Lithium: The demand for lithium carbonate is rapidly increasing, but capacity is lagging, leading to a short-run gap between supply and demand

Lithium battery manufacturers can invest in the upstream and strengthen control of raw material supply. With the increase in cobalt prices, competition between tech companies and EV battery manufacturers/OEMs for cobalt resources has intensified. Apple is negotiating on the long-term purchase of metallic cobalt from mining companies, seeking five-year or even longer stable contracts. Tesla and BMW have announced negotiations with mining companies to ensure raw material supply. In China, CATL and BYD have strengthened their supply chain and control of upstream battery materials in 2017.

Further promotion of NCM/NCA batteries will drive demand for raw materials even while new capacity is limited in the short run. The market is concerned that prices of raw materials will soar over the next three to five years. However, with increases in capacity or emergence of substitute materials, we project that pricing will become stable within two to three years.

Take the case of cobalt for analysis. Increase in capacity of existing projects and the launch of new cobalt mine projects (there are approximately 400 active cobalt mine projects in the world) will gradually increase overall capacity. Hence, we project that the price of cobalt will stabilize after 2019 unless affected by special factors (such as political instability in Republic of Congo, the main supplier of cobalt).

Components

Cathodes account for the highest proportion of cost in battery production, reaching approximately 30% of the total cost.

In China, most components, except separators, have been supplied by local manufacturers. Strengthening R&D-driven investment should be the priority for future development.

It’s important for EV battery manufacturers to strengthen control of the value chain, push proper vertical integration, and control key upstream resources or technologies. Vertical integration is the trend, but associated risks need to be mitigated, including financial pressure, policy uncertainty and upstream material price fluctuations.

We are witnessing great changes in the EV and battery industries. To survive and thrive in this dynamic market, all players must consider carefully how to follow technology development, leverage economy of scale through capacity and capture more value through appropriate vertical integration.

Fast-Moving EV Battery Market: How to Win the Competition? was written by Yong Teng and Helen Chen, Managing Directors at L.E.K. Consulting. Yong and Helen are based in Shanghai, China.

For more information, please contact lekchina@lek.com.

Top 8 Insights From the 2018 Beauty, Health & Wellness Survey

Think nutritional supplements and skincare are of interest only to consumers of a certain age? Think again. According to L.E.K. Consulting’s third installment of a biennial survey of the healthy living marketplace, this one focusing on nutrition and skincare, some 80% of health and wellness (H&W) consumers across generations — from millennials to baby boomers — are highly engaged with both categories.

The survey captured insights from more than 1,600 respondents, representing roughly 77% of the U.S. adult population who identify with H&W themes, and generated eight key insights across categories. Together these insights make clear that consumer interest in nutritional supplements and skincare often lasts a lifetime.

For additional insights, please see L.E.K.’s 2016 Health & Wellness Survey and the two-part 2015 Health & Wellness Study: “The Many Faces of H&W Consumers” and “Six Ways to Win With H&W Consumers.”

Sample Visuals

U.K. Specialist Lending Market Trends and Outlook 2018

The U.K.’s specialist lending sector plays an essential role in providing credit to the c. 20 - 25% of the U.K.’s adult population that is considered sub-prime and is poorly served by mainstream financial institutions.

In our previous Executive Insights covering the sector’s development between 2009 and 2014 (Consumer Specialist Lending: Newly Sustainable or Another Boom-and-Bust?), we discussed its revival in the aftermath of the financial crisis. Outstanding balances at the end of 2014 had started to approach pre-financial crisis levels, which naturally raised questions about the sector’s sustainability as it navigated through changes in regulatory supervision. We highlighted the essential ingredients for success for lenders operating in this new world.

Two years on – a paradoxical overall growth story…

By early 2018, a significant majority of the sector had achieved full regulatory authorisation. Affordability assessment has become an important feature of operating in this sector and lenders that we work with have significantly enhanced their focus on both income and expenditure assessments to ensure that customers are able to repay.

This tightening of processes and focus on responsible lending might have been expected to reduce the amount of credit from specialist lenders, but the actual progression of the market has defied this logic. Between 2014 and 2016, our analysis suggests that the overall outstanding balances of lenders actively operating in this market grew at c. 9% p.a., with balances in aggregate at the end of 2016 at an all-time high of c. £16 billion (see Figure 1).

…however, there are variations at a product level

As Figure 1 shows, point of sale finance and credit cards have been the largest drivers of growth. This is in part linked to greater consumer confidence and spending over recent years, as well as expansion from the supply side driven by the greater availability of financing at retailers, the increasing maturity of lenders (including more rigorous underwriting, and better and broader use of data), and the availability of alternative funding, including securitisation. Store cards and credit unions, in contrast, experienced relatively modest growth, reflecting the greater maturity of these segments.

There are more disparate trajectories at a product level within the ‘Other unsecured products’ category (see Figure 2).

  • The increased regulatory scrutiny of and intervention in the ‘rent to own / buy’ sector has contributed to a significant decline in balances. In parallel, the ongoing migration of customer channels towards online has meant a re-evaluation of business strategy for this type of lending. This will continue to play out over 2018.
  • Growth in the car finance segment has mirrored growth rates seen in prime car finance, reflecting greater consumer confidence and used car purchases, increased availability of finance from lenders and online brokers, and a gradual progression towards higher LTV lending.
  • Following a period of steady decline to 2014, home collected credit has been relatively stable over the last two years, in part driven by the greater professionalisation of smaller players. However, we expect to see an overall decline in balances in 2017, reflecting the well-chronicled changes in the operating model of the industry leader.
  • High Cost Short Term Credit (HCSTC) lenders have resumed growth after achieving full authorisation. As expected, the leading players are now offering a range of medium-term products (12-24 months) in addition to their short-term propositions, resulting in an uptick of balances between 2015 and 2016. We expect these to have grown further in 2017.
  • Guarantor lending is now emerging as a more mainstream product, with significant growth in balances in recent years. While the industry leader continues to grow originations and, with the lion’s share of the market, drive growth of the category overall, a couple of smaller players are also beginning to reach maturity.
  • This period also witnessed the growth of longer-term unsecured loans at APRs in excess of 40%, completed both through branch and online / remote channels. Despite advances in scoring and risk assessment, the latter continues to be a challenging channel to operate in and we may very well see some changes to this landscape in the next twelve months.

Standing back from the individual product level, there has also been some momentum towards multiple product offerings from some of the larger market participants. However, this has largely stopped short of any genuinely integrated offering that provides a holistic solution to customers’ borrowing needs.

Our views on the health of the market and outlook

The industry is far more mature in its post-authorisation phase and credit is due to the regulator for having taken the industry through this process diligently. Consumers are, with few exceptions, being treated fairly, and affordability and forbearance are part and parcel of business as usual. Existing businesses continue to innovate around their propositions and products, and new entrants are operating under the stricter rules of the game. With some exceptions, in 2017 we expect the sector to have seen continued strong growth of balances.

Looking at 2018, there continues to be considerable unmet demand. However, economic uncertainty remains the key unknown at an industry level. While consumer affordability assessment has certainly been made more robust and there are built-in buffers in most players’ income / expenditure assessments, there may be some adverse impacts to originations and default rates should a slowdown materialise.

Beyond this, the potential for a more integrated “whole of customer” offering remains, and the impact of Open Banking / PSD2, may offer further opportunities for non-standard lenders to compete at the margins with prime lenders and banks in some product categories. But it’s early days in these areas, and we don’t expect 2018 to see market-altering progress.

Deposits Strategy: An Inflection Point for Challenger Banks?

The financial crisis and the era of ultra-low interest rates that followed led to the emergence of niche challenger banks in the U.K. such as Aldermore, OSB and Shawbrook. They have prospered and some are now publicly listed.

In the past few years, there has been a second tranche of bank licence applications as lenders, funded by bank term loans, bonds and other means, have sought to take advantage of the low costs available from being deposit-funded. They have been encouraged by the Prudential Regulation Authority’s (PRA) fresh approach to supporting the emergence of new banks, which includes simplifying the licence application process.

As a result, the first challengers are now being threatened themselves by a second wave of new specialist lenders with banking licences. In the 10 months to the end of 2017, the PRA approved 12 new banking licence applications, according to Specialist Banking, and in its latest annual report the PRA stated that it had met with 25 prospective banks considering applying for a licence1.

The increasing crowding of this space is squeezing margins in a number of previously niche challenger markets. Head-on price competition is rife, especially in asset finance, second charge lending and invoice finance. This is forcing many challengers to take a renewed look at their funding and to consider whether they could generate the volumes of deposits required at lower savings rates than those needed to be ranked a best buy.

This Executive Insights examines the key considerations for the challenger banks.

Deposit dynamics

The deposit market has a wide range of player types: high street banks; building societies; well-known challengers such as the Co-op, TSB and Virgin; challengers with far less established brands; and the subsidiaries of foreign banks, many of which also suffer from poor brand recognition in the U.K.

The market also has a highly segmented customer base. The majority of people hold at least some savings with the bank that holds their current account, relationships that often last decades. Around £50 billion of savings is regularly moved to ensure it’s always rewarded with a best-buy interest rate — these customers are content to save with a bank whose brand they do not know. A further £100 billion of savings is placed into new accounts by brand-conscious customers who are not readily accessible to challenger banks. A final segment is the wealthy, who want to diversify large deposits to maximise their protection from the government’s guarantee scheme.

Competitive tension is based around access to savings, the interest rates offered and how they vary over time, including through bonuses, the strength of customer relationships, and marketing and distribution.

It is a tough market for challengers because the high street banks have two structural advantages. First, their brand strength is unrivalled — in spite of the damage to their reputations from the financial crisis — and with their scale they can market heavily at a national level. Second, as the main bank for most people, through a current account or mortgage, it is easier for them to offer an additional account to customers. These advantages are enough for the major banks to raise the deposit funds they want — they are all well-capitalised now — so they don’t need to try harder by offering market-leading savings rates and features.

The challengers do not have the scale, resources or brand equity to compete with such marketing heft. In many cases they don’t have any form of relationship with potential retail savers because they don’t offer consumer banking products. And for those banks that do, their retail products tend to be in limited niche areas (for example, point-of-sale lending or near-prime motor finance) so can only ever provide a small target audience for deposit accounts. Offering very low interest rate products as the high street banks do is therefore not a realistic possibility for the challengers.

A few challengers do have standalone deposit accounts and have outsourced them to one of the few options, the Newcastle Building Society, saving themselves the cost and regulatory burden of setting up the business themselves. The flip side is that outsourcing to the same place makes differentiation very difficult, and the cost and regulatory burden argument becomes less compelling the larger the challenger becomes.

Challenger options

While the deposit market might seem impenetrable to many challengers, they should not write it off. There are two key strategies that they should consider to build share, recognising that they will not be able to compete head-on with the high street giants.

Focus on less competitive niches

Find market segments that are less well served and innovate to create savings products that are attractive to them with competitive savings rates. Good examples include Masthaven, which launched as a retail bank in 2016 and offers bespoke duration savings products, and German bank Fidor, which set-up in the U.K. in 2015 and offers savers access to online advice from other members of the bank’s saving community (providing rewards for each question posted).

Succeeding with this strategy requires in-depth customer research to identify niches where new products can add significant value. This approach may also require insourcing the savings platform, a strategy Masthaven has followed.

Adopt a new channel and marketing strategy

Innovative ideas cleverly marketed to better served customer segments can also win. Other parts of the financial services industry have done this well: Octopus Cash has developed a competitive edge through offering better-off savers the best interest rates by continually moving their money for them to the highest-earning accounts, taking care to preserve their protections under the Financial Services Compensation Scheme by spreading funds across multiple accounts as required; and Hargreaves Lansdown has built a position as the go-to online platform for direct investment by sophisticated private investors.

Challengers should also consider affinity strategies, acting as the white-label bank for well-known brands and profitable segments. They can learn from the high street banks: Bank of Scotland and RBS set up Sainsbury’s and Tesco’s banks, both now self-operated, to access the supermarkets’ huge customer bases, and M&S Bank is part of HSBC. Hard, yes, but there will be opportunities for the challengers that work at it.

Online affinity communities should also be explored, particularly for special interest groups and younger generations who have only known an online world. Again, examples from other areas of financial services demonstrate what can be achieved: Carole Nash is a successful motorbike insurance business that started out focusing on vintage models; Prodigy Finance is an online platform that provides what it calls borderless loans to internationally mobile postgraduates to study at leading universities. Both benefit from customers’ affinity and engagement with the underlying product (i.e. the bike or the university) to drive two things: first, deeper relationships to achieve a combination of better underwriting results than technical underwriting criteria would imply are possible; and second, broader and more valuable customer relationships.

Bigger questions

Before aggressively pursuing an innovative deposits strategy, challengers must question the rationale for such a move — it’s certainly something that investors and the market at large can be expected to do. There must be a sound commercial thesis that complements the overall business model.

Given the increase in competitive pressure, they should first be reviewing how to optimise the margins of their lending businesses, perhaps focusing on higher-margin subsegments2 and driving margin through increasing prices, where possible, or by reducing the volume of loans provided where necessary.

The first wave of challengers should also put a renewed emphasis on minimising their operational costs, which will have grown in step with the development of their business, for example by automating the more “vanilla” elements of lending. This automation could also reduce the time it takes for a customer to receive a loan. This could be a game changer for people who need finance quickly, potentially at high margins for the lender.

More critically, boards should be asking how sustainable their business model will be when interest rates inevitably rise a few points from their current position. Companies that analyse these strategic questions now and take action will be at a significant competitive advantage over their rivals who don’t.
 

1 - http://specialistbanking.co.uk/12-banking-applications-approved-10-months/
2 - See L.E.K. Consulting’s How Challenger Banks Can Finally Live up to Their Name: Pursue a Multi-Niche SME Strategy

Top 10 Trends Affecting the Wine Industry

The wine sector has been experiencing a number of twists and turns in recent years. From industry consolidation up and down the value chain, to changing consumer demographics and preferences, to the rise of ecommerce, here are 10 trends that are separating the winners from the losers.

1. The market is huge and growing steadily

U.S. consumers quaffed $32 billion worth of wine in 2017, and that figure is expected to reach $43 billion by 2022, an annual growth rate of more than 6%. Even if there was an economic downturn, evidence suggests the impact on wine sales would be minimal. During the last recession (2007-08), while the growth rate for volume consumption slowed, the trajectory was still positive, signaling low cyclicality. Concerns that legalization of recreational marijuana will adversely affect wine sales seem overblown. Early data from Colorado indicates legalization has not had an impact on wine consumption, which has remained constant at historical levels.

2. Premium is the place to be

If wine sales in general have been positive, the “fine and premium” category (over $10 a bottle) has been almost bubbly. The segment ended 2017 at around $17 billion, growing approximately 8% a year since 2012. This trajectory is expected to continue, with the segment reaching around $25 billion by 2022 (see Figure 1).

3. Millennials are making their mark

Not surprisingly, millennials comprise an increasing share of U.S. wine consumers. Between 2012 and 2016, Gen Xers and millennials drove overall wine market growth, increasing their share of consumption by about 8%, and edging out baby boomers as the biggest consumer segment. One estimate predicts that millennials will hold the largest share of U.S. wine consumption by 2026.1

Millennials differ from older consumers in a number of interesting ways. They have limited category loyalty, consuming beverages across categories (even during a single occasion). Compared with entry-level consumers in the 1960s, millennials have shown limited interest in the lowest-price wine segment, and as a result they made an outsize contribution to the growth of premium wines. At the same time, they are clearly value-focused consumers: They are looking for high quality at an acceptable price.

Millennials also demonstrate a high propensity to explore, favoring “new experiences” and varietals when making wine purchase decisions. This need to constantly discover something new has led to a continual rotation of “hot” varietals, which vary year by year. Rosé wines currently hold pride of place as the latest “it” wines: U.S. consumption of rosé grew by around 53% in the 52 weeks prior to June 2017, a significant rise from its 0.3% annual volume growth between 2011 and 2016.

4. “Drinking in” is winning out

Millennials are also having an impact on another trend: Unwilling to pay restaurant wine markups, consumers in general, led by millennials, are increasingly drinking their wine at home. Off-premises consumption now represents more than 80% of overall wine consumption — higher than off-premises consumption of beer or distilled spirits (see Figure 2).

5. Packaging packs a punch

As more and more consumers bring their wine home or to private social settings, they are increasingly embracing new forms of packaging that offer convenience and portability. For example, “bag-in-box” packaged wine is expected to see particularly high growth, given the low cost of production for suppliers. In fact, this trend is so strong that it has begun to move upmarket, with premium brands now using the format for 1.5-liter and 3-liter quantities. Boxed cabernet, chardonnay and pinot grigio grew more than 20% from 2015 to 2016.2  For example, Black Box from Constellation grew from 4 million to 6.6 million cases between 2014 and 2017, while Bota Box from Delicato doubled from 3 million to 6 million cases over the same period.

At the other end of the spectrum are smaller and single-serve packages. Tetra Paks have seen significant uptake, a result of both convenience (including the ability to reseal) and environmental friendliness compared with traditional packaging. Canned wine sales more than tripled between 2015 and 2017, albeit from a very small base (they represented less than 1% of overall wine sales in 2017).

Despite the buzz, widescale adoption of alternative packaging formats is likely to remain limited by consumer perceptions, shorter product shelf life and the difficulty of finding canning partners that focus primarily on beer.

6. The industry is consolidating, but buying opportunities remain

In 2017 the top 14 suppliers made up approximately 79% of the U.S. wine market by volume; however, a long tail of some 9,000 suppliers produced the remaining 21%. M&A activity is robust, with more than 30 deals for domestic vineyards in 2016. Acquisitions were made by producers of all sizes. Those of medium-to-large producers have been focused in the premium segment while smaller wineries were more concerned with securing supply, permits or capacity.

Private equity (PE) has also taken a few tentative sips, closing a number of U.S. winery deals in 2016. While wineries may not be an ideal fit for PE firms — there is a need to hold inventory over multiple years, and land and weather are also concerns — a significant opportunity exists to improve margins through better management, operations and commercialization.

It is also likely that buying opportunities will continue to arise as smaller wineries, grappling with a range of challenges, decide to sell. According to one recent survey of winery owners by Silicon Valley Bank, half say they may consider selling within the next five years (see Figure 3).

7. Labor shortages have begun to take their toll

Labor is a primary concern for the U.S. wine industry, and right now there is not enough of it. Producers rely heavily on migrant labor, and recent immigration policy reforms appear to be exacerbating the shortage. Seasonal workers, many of whom come from Mexico, are finding that crossing the border has become too expensive and too dangerous. In addition, producers are facing increased competition from alternative crops, including newly legalized marijuana, where the pay is better and the work less physically taxing.

A shortage of available temporary housing in areas affected by recent fires may further reduce the labor supply. The Northern California fires in late 2017 displaced nearly 100,000 people, including both documented and undocumented migrant farm workers. The resulting rise in the cost of accommodation may force workers to leave the area, especially undocumented farm workers who have no access to federal assistance. With no one to harvest their grapes, wineries may need to scale back production.

8. Distributor consolidation is limiting market access for all but the biggest

The top 10 U.S. wine wholesalers now hold a full 80% of the market (see Figure 4). The largest distributors are reportedly streamlining supplier relationships, seeking partnerships with strong, well-known brands with consistent and predictable sales. The numbers reflect this trend: In 2016, 95% of sales for wineries producing more than 250,000 cases were through distributors, an increase of 6% since 2014. For those producing fewer than 10,000 cases, distributors were responsible for only 33% of sales in 2016, a 6% decrease over the same period.

9. Wine shipping laws are evolving, but it’s a slow process

Ever since the 1933 repeal of Prohibition, the regulatory environment for alcohol has been slow to change. While wine shipping laws are starting to evolve, a big challenge for producers is navigating a confusing labyrinth of state regulations. For example, some states allow retail intrastate shipping while others do not. Some allow winery interstate and intrastate shipping while others do not (see Figure 5).

In 2005, the Granholm v. Heald Supreme Court decision ruled that laws permitting in-state wineries to ship to consumers but prohibiting out-of-state wineries from doing so are unconstitutional. As a result, wine shipping regulations have relaxed: Forty-four states now allow out-of-state direct-to-consumer (DTC) shipments from wineries and 14 allow out-of-state DTC shipments from retailers. Today only three states — Alabama, Oklahoma and Utah — directly prohibit DTC wine shipments. This less restrictive environment could provide an important opportunity for smaller wineries that are not represented by distributors and are struggling to reach.

10. Direct-to-consumer sales are on the rise

In fact, wineries are already jumping on the DTC bandwagon. The DTC channel hit nearly $3.1 billion in 2017 and is forecast to grow around 11% a year, reaching $5.2 billion by 2022 (see Figure 6). Not surprisingly, much of the growth in DTC is driven by smaller wineries, which often are not represented by distributors. The largest wineries are pulling back on DTC sales, with this channel representing only 6% of 2016 sales for wineries producing more than 250,000 cases, compared with 12% just two years earlier. Meanwhile, DTC accounted for more than two-thirds (68%) of 2016 sales for wineries producing fewer than 10,000 cases, a 6% jump over 2014.

While DTC has shown strong growth, it is from a relatively small base, and regulatory, logistical and consumer adoption barriers may limit the upside of this channel. These include continued prohibitions on interstate shipping in some states, challenges with shipping a heavy product that can spoil when exposed to high temperatures, and consumer preference for knowledgeable sales support when making wine purchases. In response to these obstacles, wineries are employing a number of different strategies to reach consumers directly, from on-site tours and tastings to wine clubs to selling through third-party ecommerce platforms.

1State of the Wine Industry 2018, Silicon Valley Bank
2Nielsen Consumer Insights, Interpak, Beverage Daily

Top 10 Trends Affecting the Wine Industry was written by Rob Wilson, Managing Director in L.E.K. Consulting’s Food & Beverage practice. Rob is based in Chicago.
For more information, contact consumerproducts@lek.com.
 

More Travel for Fun, Less Travel for Chores: Why Leisure Is the Key Growth Market for Transport Operators

Evolving lifestyles, consumption habits and work culture, much of it driven by the internet, have led to structural changes in the travel behavior of people in the U.K.

Since 2005, the number of trips and the overall distance traveled per person are down by nearly 10%, caused by a drop in commuting and travel for chores (e.g. business and shopping). Meanwhile, leisure travel for entertainment or day trips has increased. Even where we socialize with friends has changed, switching from a visit to their home to trips out together (see Figure 1).

This shift in emphasis from traveling as a chore to traveling to do something fun is set to continue and has significant implications for transport operators across road, rail and air, including the fast-growing ride-sharing companies.

All operators, including those thinking of entering the market, should review how they can develop competitive advantage by optimizing for these trends. For many, this will require a strategic rethink and a repositioning of their products and services.

This Executive Insights looks at these changing travel patterns and provides an overview of the eight levers of leisure travel that operators should be addressing.

Travel as a chore is down

The growth of online shopping, both from pure plays such as Amazon and from traditional retailers, is reducing the need to travel. Online retail in the U.K. has risen from 3% to 17% of total retail sales in the past decade. Continental Europe is experiencing the same shift online, particularly France and Germany, where web sales have grown 13% and 15% respectively since 2014. Supermarkets have been particularly affected. Nearly half (48%) of British people do some of their grocery shopping online, a market now worth £10 billion, and 14% do all of it online — up from 7% in 2014, says Office of National Statistics research.

Working culture has also evolved to become more flexible, with people working from home or in transit, reducing the need for the daily commute and increasing employees’ productive time. As Figure 2 shows, the proportion of U.K. commuters traveling more than three times a week declined from 85% to 72% between 2001 and 2016.

Ongoing technology improvements have played a significant role in enabling effective remote working, especially conference calls and digital video platforms such as Skype. Technology has also contributed to the decline in travel for business meetings outside the office. This is particularly the case for long-distance journeys.

Transport needs are also changing with the widespread use of smartphones, tablets and computers for communication. Rather than going to someone’s house to meet up, friends’ conversations are increasingly taking place digitally, especially through social media, instant messaging and video chat.

Travel for fun is on the rise

While there has been a steady decline in overall travel in the U.K., people are traveling more for leisure. Figure 1 shows that the average number of trips per person has been increasing since 2005 for entertainment, visiting friends outside of homes and day trips. The upswing in attendance at concerts and music festivals is one area that highlights the trend: In the four years to 2016, the number of people at such events doubled to 31 million a year, according to UK Music (see Figure 3).

The spending habits of millennials reflect the step change — they spend more on taxis, eating in restaurants and going to coffee shops and bars than did previous generations. Credit card spending data suggests that millennials spend 24% of their income on restaurants, versus 15% for older generations.

The eight key levers for leisure travel

Because such trips are optional, transport operators need to prize people away from their home comforts. The competition is not another mode or operator, but a box set and sofa. L.E.K. Consulting’s work in the sector suggests there are eight key factors that influence success in this new travel environment (see Figure 4).

Increased marketing efforts. Improved and more regular dialogue with customers through engaging marketing campaigns is important in an era in which travel is no longer always a necessity — customers need to be enticed into traveling with a particular operator. U.K. travel companies could learn from Turkish Airlines’ successful YouTube video strategy targeting millennials, and SNCF’s “It’s just next door” experiential marketing campaign to highlight the many European locations to which the French train operator travels.

Superior travel experience. With the wide variety of convenient and affordable transport options available, people need to enjoy their experiences if they are to use the same operator again — and require extremely good experiences to prompt them to recommend the operator to their friends. Trenitalia, Italy’s national train operator, has tried to differentiate in this area by creating four classes of service on its high-speed Frecciarossa trains.

Competitive loyalty schemes. Attractive loyalty schemes are crucial in many markets to increase brand loyalty and ensure repeat business. Operators should take care to tailor these schemes to their range of customer segments. The airline industry excels at this, using points, rewards and air miles to induce extra trips and create long-term customer relationships.

Real-time travel information. With overall travel continuing to decline, people will become less familiar with operators’ routes, schedules and stations. To make the customer experience as seamless as possible, operators should place renewed emphasis on improved real-time travel information via station signage, onboard screens, apps and notifications. Apps such as WienMobil in Vienna, Whim in Birmingham, U.K., and Rome2rio show how integrated travel planning is becoming more commonplace. However, no major operator has truly cracked the provision of live, accurate travel information.

Targeted event planning and partnerships. As people’s leisure travel increases, operators should consider partnerships with event organizers and ticket providers to become more than just the mode of transport for customers. This could include negotiated event discounts, early-bird tickets, or partnerships with third parties such as premium food and beverage companies to provide superior dining experiences during a journey.

Aggressive yield management. To maximize their revenues, operators should review their pricing strategy to spread customer demand and increase overall asset utilization. Uber take this approach, using demand-based pricing to keep its fares down when demand is low and to charge more during peak periods of demand.

Value-adding ancillaries. Road and rail operators should learn from airports and implement ancillary services that are natural complements to leisure journeys, such as free Wi-Fi, shopping, dining and limo services. While passengers have more disposable time at airports, there are opportunities to enhance the time customers spend at bus, coach and railway stations, adding non- farebox revenue to operators.

Flexible off-peak travel. Off-peak travel growth is outpacing peak travel, providing operators with the opportunity to offer a wider variety of flexible ticket options. Flexible part-time commuter tickets, for instance, will be attractive to remote workers who might travel to their employer’s office just a few times a week.

What to do?

The challenge for operators is how to steal share from other operators and modes in the slowly declining market for necessity travel while simultaneously building share and stimulating new trips in the growing and complex leisure markets. For many operators, this will require a shift in mindset to become more consumer-oriented, drawing on the best examples from the global transport industry. Developing a new approach requires an in-depth understanding of the different customer segments across the full door-to-door experience, and the ability to create and market differentiated service propositions.

2018 Manufacturing Priorities Survey

L.E.K. Consulting recently surveyed approximately 200 decision-makers across seven manufacturing industries to gain their perspectives on the near-term outlook for U.S.-based manufacturing. In this Executive Insights, we delve into the key findings from this proprietary research, including:

  • Manufacturers’ overall bullish outlook on investment and opportunities
  • Strategic imperatives that consist of continued investment in automation, Internet of Things (IoT)-enabled products and the evolution of customer-centricity 
  • Increasing concerns about continued access to skilled labor

Putting Context Into Strategy

Few words in business are more widely used than the ubiquitous “strategy.” This convenient label may be attached to almost any collection of our ideas in order to impart gravitas to their meaning. And yet, so often, those strategies consist of little more than a set of goals or targets, a loose sense of our direction of travel, or — worse still — an expression of unsubstantiated hope.

It is surely time to tighten up the definition of such an important component of the business lexicon. A practical definition of strategy might be “a plan to achieve an objective.” Under this interpretation, it is clear that specifying the objective, or desired future state, is essential. However, the starting point, or current state, also needs to be clearly understood. If a strategy is a plan to get from “A” to “B,” it is surprising how little attention is often given to the true characteristics of Point A. You would not get very far using a map with this approach, and in business, the understanding of Point A requires considerably more than pinpointing your current physical location.

Imagine the following situation. A stranger approaches you with a map, asking you to explain the most effective way to get to his destination. You find your current location on the map and point out the roads that offer the most direct route. The stranger shakes his head and asks you to try again. You quickly spot your mistake; he obviously does not have a car. Your new plan involves a series of train connections. Another shake of the head. Thinking now that he may be a little short of funds, you ask him how much he wishes to spend on his journey. “Nothing at all,” is the reply. You eventually ask him to explain what he really has in mind, and his answer immediately clears up the mystery — he is leading a charity walk. The advice he needs from you is to show him the most attractive route for 30 walkers through remote countryside, avoiding the large towns and main roads.

In business, too, strategies can miss the mark because we have not fully understood the context.

A structured approach to strategy development

The five headings in Figure 1 encompass the ground that should be covered to develop a robust strategy.

Context

In business, context is vital. The long-term history of acquisitions, disposals, major initiatives, people movements and financial performance often contains valuable insights about the current state of the business and the reasons for change. Motivation and the proposed speed and direction of travel have a lot to do with history. Relating the performance of your and competitors’ businesses to the correct market segmentation and share can reveal a great deal about Point A that really matters in a strategic context. We generally find that the work involved with correctly characterizing this starting position can absorb up to 70% of the effort required to formulate strategy.

Objectives

In contrast, the definition of Point B can be relatively straightforward. The shareholders, board, CEO and senior management will generally have discussed the ambitions and expectations for development over at least the next five years. Simple objectives can be powerful: Doubling the size of the business, achieving a market-leading position, and raising margins to levels attained by competitors or by the business itself in the recent past are all valid goals. The more difficult task is to ensure that these objectives have taken into account both the context (as above) and the means available (see below).

Milestones

Detailed milestones and metrics associated with individual initiatives are essential in activating strategies (see L.E.K. Consulting’s Executive Insights on Value Activation), but you also need clear and simple mechanisms for measuring progress toward your objectives at the higher strategic level. How will you know when you have arrived at your destination? What metrics would reassure you that you are on track during the journey? If the objective itself is defined as a measurable target, setting milestones simply means deciding on the timing of progress along the way. The milestones for more qualitative objectives, such as “developing a reputation as a technology leader in our field,” generally require more thought. Without measurement, a strategy loses its power to engage.

Means

The means available to pursue a strategy often receive too little attention. What strategic assets do you possess? The only steel plant in the country? Oil or gas fields with the lowest cost of production? A set of prime retail locations in every major conurbation in the country? The majority of valuable slots at a congested hub airport? Strategic assets open up valuable opportunities not available to competitors, and thus they alter the range of options that can be pursued. They may also require investment to maintain or protect, which might limit alternative development paths.

John Kay, in his book The Foundations of Corporate Success1, postulates that many of the competencies that are truly sustainable tend to fall under one of three headings:

  • Architecture (internal and external architecture and networks)
  • Reputation (all the ways in which customers perceive added value)
  • Innovation (the ability to exploit innovation more or less continuously)

A thorough review of competences in these three areas will inform both the objectives set and the strategies to attain them.

Companies often make the claim that “people are our greatest asset,” while doing little to check the veracity of that statement, maintain the asset or improve the quality of the talent pool. More time is spent translating a strategy into financial projections than is spent attempting the more difficult task of forecasting skills shortages in the key areas of the business that will deliver the strategy (see L.E.K.’s Executive Insights on Skills Management).

Questions that need to be asked include:

  • How good is the senior management team responsible for delivering the strategy?
  • How well do they work together under pressure?
  • What should be their individual focus on developing leadership skills?
  • What capacity does the team have to deliver growth strategies beyond “business as usual”?

An important aspect of answering the “means” question is to work out how much financial firepower is available for strategic development. Capital is often available to fund value-creating strategies, but there are always practical constraints on the cash at your disposal. There is also no point in developing a strategy that pitches your company into a spending war against better-funded competitors.

Strategic choices

It should be possible from the preceding four steps to define your strategy as the high-level plan to move from a clear starting position to a measurable endpoint, taking into account the means that you have available and the nuances of context and history that will influence successful delivery.

We are not talking about detailed action plans; those come later during the activation phase. The strategy needs to define the overall architecture of the plan and the principles you intend to follow. To return to the example of the charity walkers, they will proceed on foot, using pathways that take in good scenery and using the shortest route that includes facilities such as cafes and pubs and a place to stay overnight.

Strategy is all about choices — coherent choices that fit into an overarching plan to reach an objective. We often use the diagram in Figure 2 to illustrate some of the headings that are important in creating a coherent business strategy. Not all of them need to be under consideration every time, but each of the choices made must be consistent with the overall strategy. As a result, the high-level plan must be in place before making the choices that are relevant to the strategy being created.

Your strategic choices need to be coherent; they must optimize the business model you adopt for the assets at your disposal and the strength of your management team, and make full use of your predictions for the external environment. A balanced focus on all these elements is vital.

Following the COMMS framework will allow you to address the relevant questions when formulating a strategy. The acronym itself is a reminder to communicate your strategy widely throughout your organization. Everyone needs to understand the plan, feel committed to it and know the part they will play in the delivery.

1. Kay, J. (2007) The Foundations of Corporate Success: How Business Strategies Add Value. Oxford: Oxford Paperbacks.

Accelerating Electrification: Critical Steps Toward Electric Vehicle Mass Adoption

Global investment in electric vehicles (EVs) has increased rapidly in recent years. A growing number of governments around the world are seeking to grow adoption rates, and an increasing number of car manufacturers are planning to produce greater volumes and models of EVs. Some analysts estimate over US$90 billion will be invested in electric vehicle technologies globally in the years ahead. 

In this Executive Insights, we investigate 12 countries globally, including Australia, to reveal that shifting consumer purchasing behavior in most countries will take more than investments in public charging infrastructure. It will require a fundamental shift in the cost competitiveness of electric vehicles compared with internal combustion engine vehicles.

Why Companies Are Using M&A to Transform Themselves, Not Just to Grow

A brick-and-mortar retailer buys an e-commerce platform. An internet technology company picks up a mobile phone manufacturer. A chain of pharmacies announces its intent to acquire a health insurer.

Today’s corporate tie-ups increasingly aim to transform the acquirer’s business rather than reinforce it. Why? Some point to major shifts in skill sets that companies need. Others note the diminishing number of attractive same-sector acquisition targets as industries consolidate and as investors search for ways to put their growing cash reserves to work.

But there’s more to it than that. The current cohort of acquisitions goes well beyond the typical defensive, synergy-driven, horizontal integration that marked previous M&A spurts. These new deals are taking parent companies in uncharted directions. This tells us businesses aren’t acquiring other businesses simply to expand what they’re already doing. They’re doing it because, strategically, they have to — if they want to survive over the medium to long term.

Though recent acquisitions may seem idiosyncratic, they all have in common the need to find new avenues for growth in mature markets or to deal with accelerating change. Let’s unpack some recent examples.

Capability upgrades. Technology, manufacturing, research and development, or human know-how — whatever the capability, acquisitions are a way to acquire it. Along this vein, Detroit-based General Motors acquired Silicon Valley startup Cruise Automation, which makes autonomous driving systems. While Cruise is a far cry from old-line auto manufacturing, GM saw in it an opportunity to advance its own capabilities in autonomous vehicles by acquiring talent and technology that would have taken too long to develop organically. With Cruise’s capabilities, GM is now a serious contender in the autonomous vehicle race against competitors such as Waymo.

Market breakthroughs. It can take years to build distribution networks or gain a foothold in a particular market. An acquisition, though, can accomplish both in relatively short order. PetSmart, for example, launched a historic bid to take over online pet supply retailer Chewy.com, surpassing in deal value Walmart’s prior-year acquisition of Jet.com. In one fell swoop, PetSmart — a traditional retailer with more than 1,500 physical locations — claimed a place among the fastest-growing segments of the increasingly dominant world of ecommerce. Chewy, for its part, gained a bulwark against established brick-and-mortar competitors, including those operating in one of retail’s bright spots: pet care services.

Reshaping the consumer experience. When it comes to seizing opportunities among underserved consumers, industry needn’t be a barrier. That’s why recent speculation about a Walmart-Humana deal raises so many possibilities. With the average Walmart customer skewing older, its ability to offer Humana’s Medicare Advantage product — the insurer’s biggest line of business — could further serve the needs of Walmart’s senior shoppers while meeting federal value-based requirements for healthcare. And with Walmart’s presence in rural markets, Humana might just open a door to healthcare in areas where hospitals increasingly are folding up shop.

As these cases show, contemporary acquisitions increasingly cross sector lines. They often extend and upend rather than consolidate markets. They also can open up vast new ecosystems. CVS’ planned acquisition of health insurer Aetna, for instance, is also a bid for the retail giant to enter an interconnected community ranging from digital health to provider networks to corporate customers.

Whatever the imperative, recent transactions suggest a growing belief among business leaders that many of the things considered essential to company performance — including technology, talent, customer bases, products and services — can be impossible to achieve unless they buy them outright.

Getting ahead of the risks

Still, these are very risky bets to make. For them to pay off, companies can’t assume that whatever they buy can be reshaped into something strategic. Any unknowns, from customer dynamics to the new organization’s value proposition against competitors, must be made known. How realistic is leadership’s vision for the acquisition? What role does the acquisition play in advancing a strategic agenda? What will it cost to make it all happen? With asset prices at record levels, careful due diligence is more critical than ever.

Business leaders also must consider the process they’ll use to capture sought-after strategic benefits once the acquisition closes. The tradition of absorbing target companies into the corporate parent is giving way to more nuanced approaches, including:

Preservation. This approach seeks to preserve the target’s organizational autonomy (because of skills, culture, geographic distance, etc., that need to be preserved) while the strategic benefits of the acquisition may be independent of the buyer’s business. This might be important, for instance, when a company seeking to enter a new market needs to keep the target’s focus on its own market. However, back-office functions might be integrated.

Symbiosis. A symbiotic integration starts as a preservation model except that there is a greater interdependence between the strategies of the two companies. For instance, GM would likely follow a symbiotic integration of Cruise in order to preserve how Cruise operates, but will need to integrate its capabilities into GM’s autonomous vehicle efforts.

Holding. A holding company keeps the acquired entity independent of the parent. No operational integration is necessary. Private equity firms are among those that take a holding approach with the companies they acquire, as the markets, skill sets, customers and channels for each portfolio company are likely very different.

As acquisitions become more unconventional and their stakes continue to rise, companies will find that their outcomes hinge on strong competencies in due diligence and post-merger integration.

No organization can remain the same. But the changes that modern companies face are happening too quickly for them to respond with the assets and resources they already have. In this environment, acquisitions — often daring ones — are a differentiating factor. As a result, they’ve become an ongoing responsibility among executive teams accountable to investors, customers, employees and their own exacting standards for success. The good news is that there’s an extensive body of knowledge around M&A best practices — and some novel approaches to capturing the value of a target without traditional post-merger integration. Firms should make the most of these to stay relevant during this period of historic upheaval.

Editor’s note: This article previously appeared in Harvard Business Review (HBR.org)

Why Companies Are Using M&A to Transform Themselves, Not Just to Grow was written by François Mallette and John Goddard, Partners in L.E.K. Consulting’s Private Equity practice. François is based in Boston and John is based in London. 

For more information, contact privateequity@lek.com
 

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